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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. We can see that Encanto Potash Corp. (CVE:EPO) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Encanto Potash
How Much Debt Does Encanto Potash Carry?
The chart below, which you can click on for greater detail, shows that Encanto Potash had CA$9.10m in debt in March 2019; about the same as the year before. And it doesn't have much cash, so its net debt is about the same.
How Healthy Is Encanto Potash's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Encanto Potash had liabilities of CA$23.5m due within 12 months and liabilities of CA$1.40m due beyond that. Offsetting this, it had CA$4.8k in cash and CA$21.9k in receivables that were due within 12 months. So its liabilities total CA$24.9m more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the CA$4.35m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt After all, Encanto Potash would likely require a major re-capitalisation if it had to pay its creditors today. Since Encanto Potash does have net debt, we think it is worthwhile for shareholders to keep an eye on the balance sheet, over time. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Encanto Potash 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.
It seems likely shareholders hope that Encanto Potash can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.
Caveat Emptor
Over the last twelve months Encanto Potash produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping CA$999k. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. But we think that is unlikely, given it is low on liquid assets, and burned through CA$653k in the last year. So we think this stock is risky, like walking through a dirty dog park with a mask on. For riskier companies like Encanto Potash I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
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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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.