Here's Why Eden Innovations (ASX:EDE) Can Afford Some Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that Eden Innovations Ltd (ASX:EDE) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Eden Innovations

How Much Debt Does Eden Innovations Carry?

As you can see below, Eden Innovations had AU$4.91m of debt at June 2022, down from AU$5.26m a year prior. However, it does have AU$1.55m in cash offsetting this, leading to net debt of about AU$3.36m.

How Healthy Is Eden Innovations' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Eden Innovations had liabilities of AU$6.19m due within 12 months and liabilities of AU$107.1k due beyond that. Offsetting these obligations, it had cash of AU$1.55m as well as receivables valued at AU$730.5k due within 12 months. So its liabilities total AU$4.02m more than the combination of its cash and short-term receivables.

Since publicly traded Eden Innovations shares are worth a total of AU$23.3m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Eden Innovations will need earnings to service that debt. 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.

Over 12 months, Eden Innovations reported revenue of AU$5.0m, which is a gain of 52%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Eden Innovations's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Its EBIT loss was a whopping AU$5.9m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through AU$7.5m of cash over the last year. So in short it's a really risky stock. 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. Be aware that Eden Innovations is showing 5 warning signs in our investment analysis , and 2 of those shouldn't be ignored...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.