These 4 Measures Indicate That Hammond Power Solutions (TSE:HPS.A) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that Hammond Power Solutions Inc. (TSE:HPS.A) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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 Hammond Power Solutions

What Is Hammond Power Solutions's Net Debt?

The image below, which you can click on for greater detail, shows that Hammond Power Solutions had debt of CA$16.2m at the end of September 2024, a reduction from CA$22.4m over a year. However, it does have CA$49.1m in cash offsetting this, leading to net cash of CA$32.9m.

A Look At Hammond Power Solutions' Liabilities

According to the last reported balance sheet, Hammond Power Solutions had liabilities of CA$167.9m due within 12 months, and liabilities of CA$15.2m due beyond 12 months. Offsetting these obligations, it had cash of CA$49.1m as well as receivables valued at CA$144.5m due within 12 months. So it can boast CA$10.5m 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$1.57b 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!

And we also note warmly that Hammond Power Solutions grew its EBIT by 12% last year, making its debt load easier to handle. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Hammond Power Solutions 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. In the last three years, Hammond Power Solutions's free cash flow amounted to 36% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

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$32.9m, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 12% in the last twelve months. So we are not troubled with Hammond Power Solutions's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Hammond Power Solutions .

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.