Here's Why Imdex (ASX:IMD) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Imdex Limited (ASX:IMD) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Imdex

What Is Imdex's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Imdex had debt of AU$12.8m, up from AU$6.20m in one year. However, its balance sheet shows it holds AU$59.8m in cash, so it actually has AU$47.0m net cash.

A Look At Imdex's Liabilities

Zooming in on the latest balance sheet data, we can see that Imdex had liabilities of AU$48.6m due within 12 months and liabilities of AU$56.5m due beyond that. Offsetting this, it had AU$59.8m in cash and AU$42.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$3.13m.

Having regard to Imdex's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the AU$670.0m company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Imdex boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Imdex if management cannot prevent a repeat of the 27% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Imdex 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Imdex 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. Over the most recent three years, Imdex recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

We could understand if investors are concerned about Imdex's liabilities, but we can be reassured by the fact it has has net cash of AU$47.0m. And it impressed us with free cash flow of AU$38m, being 74% of its EBIT. So we are not troubled with Imdex's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Imdex that you should be aware of before investing here.

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.

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This article by Simply Wall St is general in nature. 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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