Leon's Furniture (TSE:LNF) Has A Rock Solid 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.' 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 Leon's Furniture Limited (TSE:LNF) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Leon's Furniture

How Much Debt Does Leon's Furniture Carry?

The chart below, which you can click on for greater detail, shows that Leon's Furniture had CA$90.0m in debt in June 2021; about the same as the year before. But on the other hand it also has CA$381.2m in cash, leading to a CA$291.2m net cash position.

How Strong Is Leon's Furniture's Balance Sheet?

According to the last reported balance sheet, Leon's Furniture had liabilities of CA$819.3m due within 12 months, and liabilities of CA$475.1m due beyond 12 months. Offsetting this, it had CA$381.2m in cash and CA$126.8m in receivables that were due within 12 months. So its liabilities total CA$786.4m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Leon's Furniture has a market capitalization of CA$1.86b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Leon's Furniture also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Leon's Furniture has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Leon's Furniture can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Leon's Furniture 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. Happily for any shareholders, Leon's Furniture actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

Although Leon's Furniture's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CA$291.2m. And it impressed us with free cash flow of CA$270m, being 125% of its EBIT. So we don't think Leon's Furniture'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. For example, we've discovered 2 warning signs for Leon's Furniture that you should be aware of before investing here.

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.

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.

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