We Think Imaflex (CVE:IFX) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that Imaflex Inc. (CVE:IFX) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Imaflex

What Is Imaflex's Net Debt?

The image below, which you can click on for greater detail, shows that Imaflex had debt of CA$4.87m at the end of September 2022, a reduction from CA$7.88m over a year. However, it does have CA$6.83m in cash offsetting this, leading to net cash of CA$1.96m.

How Strong Is Imaflex's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Imaflex had liabilities of CA$14.0m due within 12 months and liabilities of CA$5.15m due beyond that. Offsetting this, it had CA$6.83m in cash and CA$16.7m in receivables that were due within 12 months. So it actually has CA$4.40m more liquid assets than total liabilities.

This surplus suggests that Imaflex has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Imaflex has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Imaflex saw its EBIT decline by 2.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Imaflex'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Imaflex 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. During the last three years, Imaflex produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Imaflex has CA$1.96m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 67% of that EBIT to free cash flow, bringing in CA$3.3m. So we don't think Imaflex's use of debt is risky. 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. We've identified 1 warning sign with Imaflex , and understanding them should be part of your investment process.

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.