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.' 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, Choom Holdings Inc. (CSE:CHOO) does carry debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Choom Holdings Carry?
You can click the graphic below for the historical numbers, but it shows that Choom Holdings had CA$9.45m of debt in September 2021, down from CA$19.0m, one year before. On the flip side, it has CA$585.9k in cash leading to net debt of about CA$8.87m.
A Look At Choom Holdings' Liabilities
The latest balance sheet data shows that Choom Holdings had liabilities of CA$3.92m due within a year, and liabilities of CA$19.4m falling due after that. Offsetting these obligations, it had cash of CA$585.9k as well as receivables valued at CA$219.0k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$22.5m.
When you consider that this deficiency exceeds the company's CA$18.3m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Choom Holdings 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.
In the last year Choom Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 51%, to CA$21m. With any luck the company will be able to grow its way to profitability.
Despite the top line growth, Choom Holdings still had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping CA$5.9m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of CA$1.6m over the last twelve months. That means it's on the risky side of things. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 5 warning signs for Choom Holdings (3 make us uncomfortable!) that you should be aware of before investing here.
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.