Here's Why Arezzo Indústria e Comércio (BVMF:ARZZ3) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Arezzo Indústria e Comércio S.A. (BVMF:ARZZ3) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out the opportunities and risks within the BR Luxury industry.

What Is Arezzo Indústria e Comércio's Debt?

You can click the graphic below for the historical numbers, but it shows that Arezzo Indústria e Comércio had R$355.3m of debt in June 2022, down from R$509.5m, one year before. However, its balance sheet shows it holds R$514.5m in cash, so it actually has R$159.2m net cash.

A Look At Arezzo Indústria e Comércio's Liabilities

Zooming in on the latest balance sheet data, we can see that Arezzo Indústria e Comércio had liabilities of R$1.43b due within 12 months and liabilities of R$268.9m due beyond that. Offsetting this, it had R$514.5m in cash and R$825.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$361.5m.

Given Arezzo Indústria e Comércio has a market capitalization of R$11.3b, 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 8.3% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Arezzo Indústria e Comércio can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Arezzo Indústria e Comércio 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. Looking at the most recent three years, Arezzo Indústria e Comércio recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Arezzo Indústria e Comércio has R$159.2m in net cash. On top of that, it increased its EBIT by 8.3% in the last twelve months. So we don't have any problem with Arezzo Indústria e Comércio's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Arezzo Indústria e Comércio (of which 1 doesn't sit too well with us!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.