Here's Why Parity Group (LON:PTY) Can Afford Some Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Parity Group plc (LON:PTY) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Parity Group

How Much Debt Does Parity Group Carry?

As you can see below, Parity Group had UK£2.28m of debt at December 2021, down from UK£2.94m a year prior. On the flip side, it has UK£1.12m in cash leading to net debt of about UK£1.16m.

How Healthy Is Parity Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Parity Group had liabilities of UK£6.13m due within 12 months and liabilities of UK£71.0k due beyond that. Offsetting these obligations, it had cash of UK£1.12m as well as receivables valued at UK£4.63m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£453.0k.

Of course, Parity Group has a market capitalization of UK£7.70m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Parity Group 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.

Over 12 months, Parity Group made a loss at the EBIT level, and saw its revenue drop to UK£47m, which is a fall of 19%. We would much prefer see growth.

Caveat Emptor

While Parity Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at UK£449k. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled UK£834k in negative free cash flow over the last twelve months. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Parity Group that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.