Is VDM Group (ASX:VMG) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that VDM Group Limited (ASX:VMG) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for VDM Group

What Is VDM Group's Net Debt?

As you can see below, VDM Group had AU$10.2m of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. However, it also had AU$1.63m in cash, and so its net debt is AU$8.55m.

How Healthy Is VDM Group's Balance Sheet?

According to the balance sheet data, VDM Group had liabilities of AU$15.8m due within 12 months, but no longer term liabilities. Offsetting this, it had AU$1.63m in cash and AU$25.0k in receivables that were due within 12 months. So it has liabilities totalling AU$14.2m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's AU$10.4m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. There's no doubt that we learn most about debt from the balance sheet. But it is VDM Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, VDM Group reported revenue of AU$551k, which is a gain of 183%, although it did not report any earnings before interest and tax. So there's no doubt that shareholders are cheering for growth

Caveat Emptor

Importantly, VDM Group had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost AU$439k at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through AU$984k in negative free cash flow over the last year. That means it's on the risky side of things. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with VDM Group .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.