Would Innlanz (ASX:INL) Be Better Off With Less Debt?

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.' 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 Innlanz Limited (ASX:INL) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Innlanz

How Much Debt Does Innlanz Carry?

The image below, which you can click on for greater detail, shows that Innlanz had debt of AU$3.39m at the end of June 2023, a reduction from AU$3.79m over a year. However, it also had AU$865.7k in cash, and so its net debt is AU$2.53m.

How Strong Is Innlanz's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Innlanz had liabilities of AU$2.40m due within 12 months and liabilities of AU$2.77m due beyond that. Offsetting this, it had AU$865.7k in cash and AU$89.5k in receivables that were due within 12 months. So it has liabilities totalling AU$4.21m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Innlanz is worth AU$7.52m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Innlanz's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Innlanz reported revenue of AU$2.6m, which is a gain of 66%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Even though Innlanz managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. To be specific the EBIT loss came in at AU$91k. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled AU$97k in negative free cash flow over the last twelve months. So to be blunt we think it 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. We've identified 3 warning signs with Innlanz (at least 2 which can't be ignored) , and understanding them should be part of your investment process.

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.