Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Vaisala Oyj (HEL:VAIAS) does use debt in its business. But the real question is whether this debt is making the company risky.
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Vaisala Oyj's Net Debt?
The image below, which you can click on for greater detail, shows that Vaisala Oyj had debt of €40.1m at the end of September 2021, a reduction from €55.2m over a year. However, its balance sheet shows it holds €51.9m in cash, so it actually has €11.8m net cash.
A Look At Vaisala Oyj's Liabilities
The latest balance sheet data shows that Vaisala Oyj had liabilities of €102.4m due within a year, and liabilities of €58.5m falling due after that. Offsetting this, it had €51.9m in cash and €106.9m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.
This state of affairs indicates that Vaisala Oyj's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the €1.87b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Vaisala Oyj also has more cash than debt, so we're pretty confident it can manage its debt safely.
But the other side of the story is that Vaisala Oyj 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Vaisala Oyj's ability to maintain a healthy balance sheet going forward. 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. While Vaisala Oyj has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Vaisala Oyj produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Vaisala Oyj has €11.8m in net cash. So we are not troubled with Vaisala Oyj's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Vaisala Oyj has 1 warning sign we think you should be aware of.
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.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.