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.' 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 note that The Parkmead Group Plc (LON:PMG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. 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, 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.
How Much Debt Does Parkmead Group Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2020 Parkmead Group had UK£2.41m of debt, an increase on none, over one year. But on the other hand it also has UK£25.7m in cash, leading to a UK£23.3m net cash position.
A Look At Parkmead Group's Liabilities
The latest balance sheet data shows that Parkmead Group had liabilities of UK£4.44m due within a year, and liabilities of UK£14.0m falling due after that. Offsetting this, it had UK£25.7m in cash and UK£1.41m in receivables that were due within 12 months. So it actually has UK£8.66m more liquid assets than total liabilities.
This surplus suggests that Parkmead Group is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Parkmead Group has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Parkmead Group'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.
Over 12 months, Parkmead Group made a loss at the EBIT level, and saw its revenue drop to UK£4.1m, which is a fall of 51%. That makes us nervous, to say the least.
So How Risky Is Parkmead Group?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Parkmead Group had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through UK£4.8m of cash and made a loss of UK£482k. But the saving grace is the UK£23.3m on the balance sheet. That means it could keep spending at its current rate for more than two years. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Parkmead Group you should know about.
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. 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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