These 4 Measures Indicate That Ariadne Australia (ASX:ARA) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Ariadne Australia Limited (ASX:ARA) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ariadne Australia

What Is Ariadne Australia's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Ariadne Australia had debt of AU$18.2m, up from AU$4.85m in one year. However, its balance sheet shows it holds AU$31.2m in cash, so it actually has AU$12.9m net cash.

How Strong Is Ariadne Australia's Balance Sheet?

We can see from the most recent balance sheet that Ariadne Australia had liabilities of AU$8.14m falling due within a year, and liabilities of AU$27.4m due beyond that. Offsetting these obligations, it had cash of AU$31.2m as well as receivables valued at AU$1.79m due within 12 months. So its liabilities total AU$2.54m more than the combination of its cash and short-term receivables.

Of course, Ariadne Australia has a market capitalization of AU$94.2m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Ariadne Australia also has more cash than debt, so we're pretty confident it can manage its debt safely.

Notably, Ariadne Australia made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$1.1m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ariadne Australia will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Ariadne Australia has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Ariadne Australia actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ariadne Australia has AU$12.9m in net cash. And it impressed us with free cash flow of AU$2.6m, being 236% of its EBIT. So we don't have any problem with Ariadne Australia's use of debt. 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. We've identified 2 warning signs with Ariadne Australia (at least 1 which is concerning) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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