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

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Ariadne Australia Limited (ASX:ARA) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Ariadne Australia

What Is Ariadne Australia's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Ariadne Australia had debt of AU$27.7m, up from AU$22.3m in one year. But it also has AU$36.0m in cash to offset that, meaning it has AU$8.28m net cash.

How Healthy Is Ariadne Australia's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ariadne Australia had liabilities of AU$15.0m due within 12 months and liabilities of AU$29.9m due beyond that. On the other hand, it had cash of AU$36.0m and AU$2.13m worth of receivables due within a year. So it has liabilities totalling AU$6.84m more than its cash and near-term receivables, combined.

Given Ariadne Australia has a market capitalization of AU$122.7m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Ariadne Australia boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Ariadne Australia grew its EBIT by 1,102% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Ariadne Australia's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Ariadne Australia may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last two years, Ariadne Australia created free cash flow amounting to 10% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

We could understand if investors are concerned about Ariadne Australia's liabilities, but we can be reassured by the fact it has has net cash of AU$8.28m. And it impressed us with its EBIT growth of 1,102% over the last year. So we are not troubled with Ariadne Australia's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Ariadne Australia (including 1 which is concerning) .

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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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.