Is First Graphene (ASX:FGR) Using Debt Sensibly?

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.' 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 First Graphene Limited (ASX:FGR) 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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for First Graphene

What Is First Graphene's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2021 First Graphene had debt of AU$4.93m, up from none in one year. However, it does have AU$7.08m in cash offsetting this, leading to net cash of AU$2.14m.

How Strong Is First Graphene's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that First Graphene had liabilities of AU$6.77m due within 12 months and no liabilities due beyond that. On the other hand, it had cash of AU$7.08m and AU$86.0k worth of receivables due within a year. So it actually has AU$393.1k more liquid assets than total liabilities.

This state of affairs indicates that First Graphene's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the AU$129.3m company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that First Graphene has more cash than debt is arguably a good indication that it can manage its debt safely. 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 First Graphene will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Given it has no significant operating revenue at the moment, shareholders will be hoping First Graphene can make progress and gain better traction for the business, before it runs low on cash.

So How Risky Is First Graphene?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months First Graphene lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through AU$8.6m of cash and made a loss of AU$6.3m. Given it only has net cash of AU$2.14m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. For example First Graphene has 6 warning signs (and 3 which are significant) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.