Does Taylor Wimpey (LON:TW.) Have A Healthy Balance Sheet?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Taylor Wimpey plc (LON:TW.) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Taylor Wimpey

What Is Taylor Wimpey's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Taylor Wimpey had UK£84.0m of debt in December 2021, down from UK£103.6m, one year before. However, it does have UK£921.0m in cash offsetting this, leading to net cash of UK£837.0m.

How Strong Is Taylor Wimpey's Balance Sheet?

The latest balance sheet data shows that Taylor Wimpey had liabilities of UK£1.04b due within a year, and liabilities of UK£890.7m falling due after that. On the other hand, it had cash of UK£921.0m and UK£169.2m worth of receivables due within a year. So it has liabilities totalling UK£835.6m more than its cash and near-term receivables, combined.

Given Taylor Wimpey has a market capitalization of UK£5.29b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Taylor Wimpey also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Taylor Wimpey grew its EBIT by 125% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Taylor Wimpey's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Taylor Wimpey 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. Looking at the most recent three years, Taylor Wimpey recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although Taylor Wimpey's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£837.0m. And it impressed us with its EBIT growth of 125% over the last year. So we don't think Taylor Wimpey's use of debt is risky. 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. We've identified 1 warning sign with Taylor Wimpey , and understanding them should be part of your investment process.

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.

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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.