Is Cake Box Holdings (LON:CBOX) 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.' 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. As with many other companies Cake Box Holdings Plc (LON:CBOX) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Cake Box Holdings

What Is Cake Box Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Cake Box Holdings had debt of UK£1.52m at the end of September 2020, a reduction from UK£1.67m over a year. But on the other hand it also has UK£5.34m in cash, leading to a UK£3.82m net cash position.

How Healthy Is Cake Box Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cake Box Holdings had liabilities of UK£3.90m due within 12 months and liabilities of UK£1.90m due beyond that. Offsetting this, it had UK£5.34m in cash and UK£1.60m in receivables that were due within 12 months. So it actually has UK£1.13m more liquid assets than total liabilities.

This state of affairs indicates that Cake Box Holdings'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 UK£82.0m company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Cake Box Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

While Cake Box Holdings doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 Cake Box Holdings'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 company can only pay off debt with cold hard cash, not accounting profits. Cake Box Holdings 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 most recent three years, Cake Box Holdings recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Cake Box Holdings has UK£3.82m in net cash and a decent-looking balance sheet. So we are not troubled with Cake Box Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Cake Box Holdings 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. 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.
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