Is Pivotal Systems (ASX:PVS) Using Debt Sensibly?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Pivotal Systems Corporation (ASX:PVS) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Pivotal Systems

What Is Pivotal Systems's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Pivotal Systems had US$3.18m of debt, an increase on none, over one year. However, its balance sheet shows it holds US$9.12m in cash, so it actually has US$5.94m net cash.

How Strong Is Pivotal Systems's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Pivotal Systems had liabilities of US$8.54m due within 12 months and liabilities of US$2.68m due beyond that. Offsetting this, it had US$9.12m in cash and US$5.95m in receivables that were due within 12 months. So it can boast US$3.86m more liquid assets than total liabilities.

This surplus suggests that Pivotal Systems has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Pivotal Systems boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Pivotal Systems can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Pivotal Systems's revenue was pretty flat, and it made a negative EBIT. While that's not too bad, we'd prefer see growth.

So How Risky Is Pivotal Systems?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Pivotal Systems had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through US$14m of cash and made a loss of US$9.8m. Given it only has net cash of US$5.94m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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 Pivotal Systems 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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