Does Washington H. Soul Pattinson (ASX:SOL) Have A Healthy Balance Sheet?

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.' 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 can see that Washington H. Soul Pattinson and Company Limited (ASX:SOL) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Washington H. Soul Pattinson

What Is Washington H. Soul Pattinson's Net Debt?

The image below, which you can click on for greater detail, shows that Washington H. Soul Pattinson had debt of AU$505.2m at the end of July 2022, a reduction from AU$1.04b over a year. But on the other hand it also has AU$1.08b in cash, leading to a AU$574.1m net cash position.

A Look At Washington H. Soul Pattinson's Liabilities

According to the last reported balance sheet, Washington H. Soul Pattinson had liabilities of AU$402.3m due within 12 months, and liabilities of AU$1.03b due beyond 12 months. Offsetting these obligations, it had cash of AU$1.08b as well as receivables valued at AU$79.8m due within 12 months. So it has liabilities totalling AU$270.3m more than its cash and near-term receivables, combined.

Since publicly traded Washington H. Soul Pattinson shares are worth a total of AU$9.82b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Washington H. Soul Pattinson also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Washington H. Soul Pattinson grew its EBIT by 374% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Washington H. Soul Pattinson's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Washington H. Soul Pattinson 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. During the last two years, Washington H. Soul Pattinson produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Washington H. Soul Pattinson's liabilities, but we can be reassured by the fact it has has net cash of AU$574.1m. And it impressed us with its EBIT growth of 374% over the last year. So we don't think Washington H. Soul Pattinson's use of debt is 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. For instance, we've identified 2 warning signs for Washington H. Soul Pattinson (1 makes us a bit uncomfortable) 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.