iCandy Interactive (ASX:ICI) Seems To Use Debt Rather Sparingly

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.' 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. As with many other companies iCandy Interactive Limited (ASX:ICI) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out the opportunities and risks within the AU Entertainment industry.

What Is iCandy Interactive's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 iCandy Interactive had debt of AU$9.62m, up from AU$295.3k in one year. However, its balance sheet shows it holds AU$28.7m in cash, so it actually has AU$19.1m net cash.

How Healthy Is iCandy Interactive's Balance Sheet?

According to the balance sheet data, iCandy Interactive had liabilities of AU$19.5m due within 12 months, but no longer term liabilities. On the other hand, it had cash of AU$28.7m and AU$11.0m worth of receivables due within a year. So it can boast AU$20.2m more liquid assets than total liabilities.

This surplus suggests that iCandy Interactive is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that iCandy Interactive has more cash than debt is arguably a good indication that it can manage its debt safely.

Although iCandy Interactive made a loss at the EBIT level, last year, it was also good to see that it generated AU$573k in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is iCandy Interactive's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While iCandy Interactive 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 last year, iCandy Interactive actually produced more free cash flow than EBIT. 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 it is always sensible to investigate a company's debt, in this case iCandy Interactive has AU$19.1m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of AU$2.4m, being 414% of its EBIT. So we don't think iCandy Interactive's use of debt is risky. 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 instance, we've identified 2 warning signs for iCandy Interactive (1 is significant) 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.