Is Elmo Software (ASX:ELO) Using Debt In A Risky Way?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Elmo Software Limited (ASX:ELO) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Elmo Software

What Is Elmo Software's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Elmo Software had AU$40.5m of debt, an increase on none, over one year. However, it does have AU$58.4m in cash offsetting this, leading to net cash of AU$17.9m.

A Look At Elmo Software's Liabilities

According to the last reported balance sheet, Elmo Software had liabilities of AU$89.8m due within 12 months, and liabilities of AU$78.2m due beyond 12 months. Offsetting these obligations, it had cash of AU$58.4m as well as receivables valued at AU$21.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$88.4m.

While this might seem like a lot, it is not so bad since Elmo Software has a market capitalization of AU$306.4m, 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. Despite its noteworthy liabilities, Elmo Software 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 Elmo Software can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Elmo Software wasn't profitable at an EBIT level, but managed to grow its revenue by 43%, to AU$82m. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Elmo Software?

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 Elmo Software lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through AU$26m of cash and made a loss of AU$66m. While this does make the company a bit risky, it's important to remember it has net cash of AU$17.9m. That kitty means the company can keep spending for growth for at least two years, at current rates. With very solid revenue growth in the last year, Elmo Software may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger 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. To that end, you should be aware of the 2 warning signs we've spotted with Elmo Software .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.