We Think Credit Intelligence (ASX:CI1) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Credit Intelligence Limited (ASX:CI1) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Credit Intelligence

What Is Credit Intelligence's Net Debt?

The image below, which you can click on for greater detail, shows that Credit Intelligence had debt of AU$2.31m at the end of December 2021, a reduction from AU$3.02m over a year. However, its balance sheet shows it holds AU$3.01m in cash, so it actually has AU$700.2k net cash.

How Strong Is Credit Intelligence's Balance Sheet?

The latest balance sheet data shows that Credit Intelligence had liabilities of AU$5.16m due within a year, and liabilities of AU$1.05m falling due after that. Offsetting this, it had AU$3.01m in cash and AU$10.7m in receivables that were due within 12 months. So it actually has AU$7.54m more liquid assets than total liabilities.

This excess liquidity is a great indication that Credit Intelligence's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Credit Intelligence has more cash than debt is arguably a good indication that it can manage its debt safely.

Importantly, Credit Intelligence's EBIT fell a jaw-dropping 55% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Credit Intelligence 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. In the last three years, Credit Intelligence's free cash flow amounted to 38% 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$700.2k in net cash and a decent-looking balance sheet. So we don't have any problem with Credit Intelligence's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with Credit Intelligence , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.