Does Credit Intelligence (ASX:CI1) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Credit Intelligence Limited (ASX:CI1) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Credit Intelligence

What Is Credit Intelligence's Debt?

As you can see below, at the end of June 2022, Credit Intelligence had AU$2.20m of debt, up from AU$1.90m a year ago. Click the image for more detail. But it also has AU$3.59m in cash to offset that, meaning it has AU$1.39m net cash.

How Strong Is Credit Intelligence's Balance Sheet?

We can see from the most recent balance sheet that Credit Intelligence had liabilities of AU$5.79m falling due within a year, and liabilities of AU$1.05m due beyond that. Offsetting these obligations, it had cash of AU$3.59m as well as receivables valued at AU$10.6m due within 12 months. So it can boast AU$7.34m more liquid assets than total liabilities.

This surplus strongly suggests that Credit Intelligence has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Credit Intelligence has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Credit Intelligence has increased its EBIT by 7.7% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Credit Intelligence'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Credit Intelligence 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 three years, Credit Intelligence's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Credit Intelligence has AU$1.39m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 7.7% in the last twelve months. So is Credit Intelligence's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Credit Intelligence (1 is potentially serious) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.