We Think Orcoda (ASX:ODA) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Orcoda Limited (ASX:ODA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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. 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 Orcoda

What Is Orcoda's Debt?

As you can see below, at the end of June 2023, Orcoda had AU$4.04m of debt, up from AU$1.96m a year ago. Click the image for more detail. However, it does have AU$4.45m in cash offsetting this, leading to net cash of AU$416.2k.

How Strong Is Orcoda's Balance Sheet?

According to the last reported balance sheet, Orcoda had liabilities of AU$3.55m due within 12 months, and liabilities of AU$2.97m due beyond 12 months. Offsetting this, it had AU$4.45m in cash and AU$2.31m in receivables that were due within 12 months. So it actually has AU$244.3k more liquid assets than total liabilities.

This state of affairs indicates that Orcoda's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the AU$52.4m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Orcoda has more cash than debt is arguably a good indication that it can manage its debt safely.

One way Orcoda could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 14%, as it did over the last year. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Orcoda'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Orcoda has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Orcoda actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Orcoda has net cash of AU$416.2k, as well as more liquid assets than liabilities. The cherry on top was that in converted 184% of that EBIT to free cash flow, bringing in AU$2.5m. So is Orcoda's debt a risk? It doesn't seem so to us. 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 3 warning signs for Orcoda you should be aware of.

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.