Is Aroma AD (BUL:AROM) A Risky Investment?

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.' 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 Aroma AD (BUL:AROM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Aroma AD

How Much Debt Does Aroma AD Carry?

As you can see below, at the end of March 2024, Aroma AD had лв4.11m of debt, up from лв3.63m a year ago. Click the image for more detail. However, it does have лв4.13m in cash offsetting this, leading to net cash of лв19.0k.

How Healthy Is Aroma AD's Balance Sheet?

We can see from the most recent balance sheet that Aroma AD had liabilities of лв6.67m falling due within a year, and liabilities of лв5.38m due beyond that. On the other hand, it had cash of лв4.13m and лв8.31m worth of receivables due within a year. So it actually has лв396.0k more liquid assets than total liabilities.

This short term liquidity is a sign that Aroma AD could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Aroma AD has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Aroma AD grew its EBIT by 124% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Aroma AD's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Aroma AD may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Aroma AD recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case Aroma AD has лв19.0k in net cash and a decent-looking balance sheet. And we liked the look of last year's 124% year-on-year EBIT growth. So we are not troubled with Aroma AD's debt use. When analysing debt levels, the balance sheet is the obvious place to start. 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 4 warning signs for Aroma AD (of which 3 are a bit unpleasant!) you should know about.

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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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com