Does SOL Global Investments (CSE:SOL) Have A Healthy Balance Sheet?

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.' 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 SOL Global Investments Corp. (CSE:SOL) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for SOL Global Investments

How Much Debt Does SOL Global Investments Carry?

You can click the graphic below for the historical numbers, but it shows that SOL Global Investments had CA$48.7m of debt in November 2021, down from CA$53.0m, one year before. However, it does have CA$15.4m in cash offsetting this, leading to net debt of about CA$33.3m.

A Look At SOL Global Investments' Liabilities

The latest balance sheet data shows that SOL Global Investments had liabilities of CA$62.9m due within a year, and liabilities of CA$59.3m falling due after that. On the other hand, it had cash of CA$15.4m and CA$18.2m worth of receivables due within a year. So its liabilities total CA$88.5m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CA$42.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, SOL Global Investments would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

SOL Global Investments's net debt is only 0.14 times its EBITDA. And its EBIT covers its interest expense a whopping 25.5 times over. So we're pretty relaxed about its super-conservative use of debt. On top of that, SOL Global Investments grew its EBIT by 90% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since SOL Global Investments will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last two years, SOL Global Investments created free cash flow amounting to 11% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

While SOL Global Investments's level of total liabilities has us nervous. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. When we consider all the factors discussed, it seems to us that SOL Global Investments is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 3 warning signs with SOL Global Investments (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.