Does Verde AgriTech (TSE:NPK) 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.' 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. Importantly, Verde AgriTech Ltd (TSE:NPK) does carry debt. 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Verde AgriTech

What Is Verde AgriTech's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Verde AgriTech had CA$8.91m of debt, an increase on CA$3.20m, over one year. On the flip side, it has CA$1.59m in cash leading to net debt of about CA$7.32m.

How Healthy Is Verde AgriTech's Balance Sheet?

According to the last reported balance sheet, Verde AgriTech had liabilities of CA$15.7m due within 12 months, and liabilities of CA$8.06m due beyond 12 months. Offsetting these obligations, it had cash of CA$1.59m as well as receivables valued at CA$20.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$1.68m.

Having regard to Verde AgriTech's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CA$311.3m company is struggling for cash, we still think it's worth monitoring its balance sheet.

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.

Verde AgriTech's net debt is only 0.35 times its EBITDA. And its EBIT covers its interest expense a whopping 32.0 times over. So we're pretty relaxed about its super-conservative use of debt. Although Verde AgriTech made a loss at the EBIT level, last year, it was also good to see that it generated CA$20m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Verde AgriTech's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Verde AgriTech burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Verde AgriTech's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. When we consider all the elements mentioned above, it seems to us that Verde AgriTech is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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 3 warning signs with Verde AgriTech (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

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.