Is Honkarakenne Oyj (HEL:HONBS) A Risky Investment?

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. Importantly, Honkarakenne Oyj (HEL:HONBS) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Honkarakenne Oyj

What Is Honkarakenne Oyj's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Honkarakenne Oyj had €3.30m of debt, an increase on €2.00m, over one year. However, it does have €6.90m in cash offsetting this, leading to net cash of €3.60m.

A Look At Honkarakenne Oyj's Liabilities

The latest balance sheet data shows that Honkarakenne Oyj had liabilities of €18.5m due within a year, and liabilities of €3.20m falling due after that. On the other hand, it had cash of €6.90m and €5.40m worth of receivables due within a year. So its liabilities total €9.40m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Honkarakenne Oyj is worth €34.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Honkarakenne Oyj also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Honkarakenne Oyj grew its EBIT by 4.0% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Honkarakenne Oyj can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Honkarakenne Oyj 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. Over the last three years, Honkarakenne Oyj actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Honkarakenne Oyj does have more liabilities than liquid assets, it also has net cash of €3.60m. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in €5.9m. So we don't think Honkarakenne Oyj'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. To that end, you should be aware of the 3 warning signs we've spotted with Honkarakenne Oyj .

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.