Does Taylor Wimpey (LON:TW.) Have A Healthy 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.' 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 Taylor Wimpey plc (LON:TW.) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Debt?

As you can see below, Taylor Wimpey had UK£87.0m of debt at July 2022, down from UK£99.1m a year prior. But on the other hand it also has UK£729.4m in cash, leading to a UK£642.4m net cash position.

A Look At Taylor Wimpey's Liabilities

Zooming in on the latest balance sheet data, we can see that Taylor Wimpey had liabilities of UK£1.30b due within 12 months and liabilities of UK£852.1m due beyond that. Offsetting this, it had UK£729.4m in cash and UK£192.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£1.23b.

This deficit isn't so bad because Taylor Wimpey is worth UK£3.80b, 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. Despite its noteworthy liabilities, Taylor Wimpey boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Taylor Wimpey grew its EBIT by 8.6% in the last year, making that debt load look even more manageable. 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 company can only pay off debt with cold hard cash, not accounting profits. 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. In the last three years, Taylor Wimpey's free cash flow amounted to 39% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

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£642.4m. On top of that, it increased its EBIT by 8.6% in the last twelve months. So we don't have any problem with Taylor Wimpey's use of debt. 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 - Taylor Wimpey has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.