GR Engineering Services (ASX:GNG) Has A Rock Solid 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.' 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 GR Engineering Services Limited (ASX:GNG) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for GR Engineering Services

What Is GR Engineering Services's Debt?

The image below, which you can click on for greater detail, shows that GR Engineering Services had debt of AU$2.42m at the end of June 2021, a reduction from AU$3.40m over a year. However, its balance sheet shows it holds AU$69.0m in cash, so it actually has AU$66.6m net cash.

How Healthy Is GR Engineering Services' Balance Sheet?

We can see from the most recent balance sheet that GR Engineering Services had liabilities of AU$100.0m falling due within a year, and liabilities of AU$5.72m due beyond that. On the other hand, it had cash of AU$69.0m and AU$51.9m worth of receivables due within a year. So it actually has AU$15.1m more liquid assets than total liabilities.

This short term liquidity is a sign that GR Engineering Services could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, GR Engineering Services boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, GR Engineering Services turned things around in the last 12 months, delivering and EBIT of AU$31m. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if GR Engineering Services 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While GR Engineering Services has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, GR Engineering Services actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that GR Engineering Services has net cash of AU$66.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of AU$48m, being 154% of its EBIT. So is GR Engineering Services's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for GR Engineering Services that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.

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