Stock Analysis

Is Firefinch (ASX:FFX) Using Debt In A Risky Way?

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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Firefinch Limited (ASX:FFX) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. When we think about a company's use of debt, we first look at cash and debt together.

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How Much Debt Does Firefinch Carry?

As you can see below, Firefinch had AU$14.8m of debt at December 2021, down from AU$16.9m a year prior. However, its balance sheet shows it holds AU$148.9m in cash, so it actually has AU$134.1m net cash.

ASX:FFX Debt to Equity History May 18th 2022

A Look At Firefinch's Liabilities

The latest balance sheet data shows that Firefinch had liabilities of AU$73.4m due within a year, and liabilities of AU$23.9m falling due after that. On the other hand, it had cash of AU$148.9m and AU$7.18m worth of receivables due within a year. So it can boast AU$58.8m more liquid assets than total liabilities.

This surplus suggests that Firefinch has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Firefinch 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 Firefinch can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Firefinch wasn't profitable at an EBIT level, but managed to grow its revenue by 436%, to AU$109m. That's virtually the hole-in-one of revenue growth!

So How Risky Is Firefinch?

Statistically speaking companies that lose money are riskier than those that make money. And we do note that Firefinch had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of AU$68m and booked a AU$42m accounting loss. Given it only has net cash of AU$134.1m, the company may need to raise more capital if it doesn't reach break-even soon. Importantly, Firefinch's revenue growth is hot to trot. High growth pre-profit companies may well be risky, but they can also offer great 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. Be aware that Firefinch is showing 4 warning signs in our investment analysis , and 2 of those are potentially serious...

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.

Valuation is complex, but we're helping make it simple.

Find out whether Firefinch is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.