Here's Why Eden Innovations (ASX:EDE) Can Afford Some 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Eden Innovations Ltd (ASX:EDE) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Eden Innovations

What Is Eden Innovations's Net Debt?

The image below, which you can click on for greater detail, shows that Eden Innovations had debt of AU$4.78m at the end of December 2021, a reduction from AU$5.10m over a year. However, it also had AU$4.11m in cash, and so its net debt is AU$667.3k.

A Look At Eden Innovations' Liabilities

The latest balance sheet data shows that Eden Innovations had liabilities of AU$6.03m due within a year, and liabilities of AU$19.9k falling due after that. On the other hand, it had cash of AU$4.11m and AU$393.5k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$1.54m.

Of course, Eden Innovations has a market capitalization of AU$37.0m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Eden Innovations'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.

In the last year Eden Innovations wasn't profitable at an EBIT level, but managed to grow its revenue by 32%, to AU$3.7m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

While we can certainly appreciate Eden Innovations's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable AU$5.6m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled AU$6.3m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 5 warning signs for Eden Innovations you should be aware of, and 1 of them is a bit unpleasant.

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.