Arezzo Indústria e Comércio (BVMF:ARZZ3) 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.' 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 can see that Arezzo Indústria e Comércio S.A. (BVMF:ARZZ3) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Arezzo Indústria e Comércio

What Is Arezzo Indústria e Comércio's Net Debt?

The image below, which you can click on for greater detail, shows that Arezzo Indústria e Comércio had debt of R$411.5m at the end of September 2022, a reduction from R$568.3m over a year. However, it does have R$442.9m in cash offsetting this, leading to net cash of R$31.4m.

How Healthy Is Arezzo Indústria e Comércio's Balance Sheet?

The latest balance sheet data shows that Arezzo Indústria e Comércio had liabilities of R$1.50b due within a year, and liabilities of R$320.5m falling due after that. Offsetting these obligations, it had cash of R$442.9m as well as receivables valued at R$990.7m due within 12 months. So it has liabilities totalling R$388.0m more than its cash and near-term receivables, combined.

Given Arezzo Indústria e Comércio has a market capitalization of R$8.90b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Arezzo Indústria e Comércio boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Arezzo Indústria e Comércio grew its EBIT by 3.2% in the last year, making that debt load look even more manageable. 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 Arezzo Indústria e Comércio's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Arezzo Indústria e Comércio 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. Looking at the most recent three years, Arezzo Indústria e Comércio recorded free cash flow of 20% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

We could understand if investors are concerned about Arezzo Indústria e Comércio's liabilities, but we can be reassured by the fact it has has net cash of R$31.4m. And it also grew its EBIT by 3.2% over the last year. So we are not troubled with Arezzo Indústria e Comércio's debt use. 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 learn about the 2 warning signs we've spotted with Arezzo Indústria e Comércio (including 1 which is a bit concerning) .

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.