These 4 Measures Indicate That Inter-Rock Minerals (CVE:IRO) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Inter-Rock Minerals Inc. (CVE:IRO) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Inter-Rock Minerals

How Much Debt Does Inter-Rock Minerals Carry?

As you can see below, Inter-Rock Minerals had US$3.90m of debt at September 2022, down from US$7.70m a year prior. However, it also had US$3.80m in cash, and so its net debt is US$105.0k.

A Look At Inter-Rock Minerals' Liabilities

Zooming in on the latest balance sheet data, we can see that Inter-Rock Minerals had liabilities of US$6.88m due within 12 months and liabilities of US$4.40m due beyond that. Offsetting this, it had US$3.80m in cash and US$7.89m in receivables that were due within 12 months. So it can boast US$409.0k more liquid assets than total liabilities.

This short term liquidity is a sign that Inter-Rock Minerals could probably pay off its debt with ease, as its balance sheet is far from stretched. But either way, Inter-Rock Minerals has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Inter-Rock Minerals has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.028 and EBIT of 13.5 times the interest expense. Indeed relative to its earnings its debt load seems light as a feather. Also positive, Inter-Rock Minerals grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Inter-Rock Minerals will need earnings to service that debt. 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Inter-Rock Minerals produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Inter-Rock Minerals's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Considering this range of factors, it seems to us that Inter-Rock Minerals is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Inter-Rock Minerals is showing 2 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.