COSOL (ASX:COS) Has A Pretty Healthy Balance Sheet

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. We note that COSOL Limited (ASX:COS) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is COSOL's Net Debt?

As you can see below, at the end of June 2025, COSOL had AU$25.9m of debt, up from AU$18.7m a year ago. Click the image for more detail. On the flip side, it has AU$6.09m in cash leading to net debt of about AU$19.8m.

How Healthy Is COSOL's Balance Sheet?

We can see from the most recent balance sheet that COSOL had liabilities of AU$21.7m falling due within a year, and liabilities of AU$34.6m due beyond that. On the other hand, it had cash of AU$6.09m and AU$23.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$26.6m.

While this might seem like a lot, it is not so bad since COSOL has a market capitalization of AU$90.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

Check out our latest analysis for COSOL

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

COSOL has net debt of just 1.5 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 7.1 times, which is more than adequate. But the other side of the story is that COSOL saw its EBIT decline by 4.6% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine COSOL's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, COSOL's free cash flow amounted to 42% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

COSOL's interest cover was a real positive on this analysis, as was its net debt to EBITDA. Having said that, its EBIT growth rate somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the factors mentioned above, we do feel a bit cautious about COSOL's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for COSOL you should know about.

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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.