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.' 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. We note that PolyNovo Limited (ASX:PNV) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.
Check out our latest analysis for PolyNovo
What Is PolyNovo's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2021 PolyNovo had AU$7.58m of debt, an increase on AU$7.29m, over one year. However, it does have AU$7.74m in cash offsetting this, leading to net cash of AU$155.2k.
How Strong Is PolyNovo's Balance Sheet?
According to the last reported balance sheet, PolyNovo had liabilities of AU$8.65m due within 12 months, and liabilities of AU$7.34m due beyond 12 months. Offsetting this, it had AU$7.74m in cash and AU$5.67m in receivables that were due within 12 months. So it has liabilities totalling AU$2.58m more than its cash and near-term receivables, combined.
Having regard to PolyNovo's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the AU$899.5m company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, PolyNovo boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if PolyNovo can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, PolyNovo reported revenue of AU$29m, which is a gain of 31%, 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.
So How Risky Is PolyNovo?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year PolyNovo had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of AU$3.8m and booked a AU$4.6m accounting loss. With only AU$155.2k on the balance sheet, it would appear that its going to need to raise capital again soon. With very solid revenue growth in the last year, PolyNovo may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. 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 1 warning sign for PolyNovo that 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.
About ASX:PNV
PolyNovo
Designs, manufactures, and sells biodegradable medical devices in the United States, Australia, New Zealand, and internationally.
High growth potential with excellent balance sheet.