Does Hammond Power Solutions (TSE:HPS.A) Have A Healthy Balance Sheet?

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.' 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. Importantly, Hammond Power Solutions Inc. (TSE:HPS.A) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Hammond Power Solutions

How Much Debt Does Hammond Power Solutions Carry?

You can click the graphic below for the historical numbers, but it shows that Hammond Power Solutions had CA$22.4m of debt in September 2023, down from CA$26.6m, one year before. But it also has CA$44.6m in cash to offset that, meaning it has CA$22.1m net cash.

A Look At Hammond Power Solutions' Liabilities

According to the last reported balance sheet, Hammond Power Solutions had liabilities of CA$147.6m due within 12 months, and liabilities of CA$8.37m due beyond 12 months. On the other hand, it had cash of CA$44.6m and CA$129.0m worth of receivables due within a year. So it actually has CA$17.6m more liquid assets than total liabilities.

This state of affairs indicates that Hammond Power Solutions' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CA$1.13b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Hammond Power Solutions boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Hammond Power Solutions grew its EBIT by 84% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hammond Power Solutions'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Hammond Power Solutions 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, Hammond Power Solutions recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hammond Power Solutions has net cash of CA$22.1m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 84% over the last year. So we don't think Hammond Power Solutions's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Hammond Power Solutions (at least 1 which is significant) , and understanding them should be part of your investment process.

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.