Health Check: How Prudently Does Jatcorp (ASX:JAT) Use 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 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. We note that Jatcorp Limited (ASX:JAT) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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.

See our latest analysis for Jatcorp

What Is Jatcorp's Debt?

You can click the graphic below for the historical numbers, but it shows that Jatcorp had AU$3.17m of debt in June 2022, down from AU$7.83m, one year before. However, it does have AU$3.86m in cash offsetting this, leading to net cash of AU$691.3k.

How Strong Is Jatcorp's Balance Sheet?

According to the last reported balance sheet, Jatcorp had liabilities of AU$9.70m due within 12 months, and liabilities of AU$5.62m due beyond 12 months. Offsetting these obligations, it had cash of AU$3.86m as well as receivables valued at AU$606.1k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$10.9m.

This deficit isn't so bad because Jatcorp is worth AU$27.5m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Jatcorp boasts net cash, so it's fair to say it does not have a heavy debt load! 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 Jatcorp 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.

Over 12 months, Jatcorp reported revenue of AU$38m, which is a gain of 81%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Jatcorp?

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 Jatcorp lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of AU$4.2m and booked a AU$7.0m accounting loss. Given it only has net cash of AU$691.3k, the company may need to raise more capital if it doesn't reach break-even soon. Jatcorp's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. Pre-profit companies are often risky, but they can also offer great rewards. 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. Case in point: We've spotted 5 warning signs for Jatcorp you should be aware of, and 2 of them are potentially serious.

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.