These 4 Measures Indicate That Associated British Foods (LON:ABF) Is Using Debt Safely

Warren Buffett famously said, '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. Importantly, Associated British Foods plc (LON:ABF) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Associated British Foods

What Is Associated British Foods's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Associated British Foods had UK£748.0m of debt, an increase on UK£440.0m, over one year. However, it does have UK£2.22b in cash offsetting this, leading to net cash of UK£1.48b.

How Strong Is Associated British Foods' Balance Sheet?

We can see from the most recent balance sheet that Associated British Foods had liabilities of UK£3.31b falling due within a year, and liabilities of UK£3.96b due beyond that. Offsetting these obligations, it had cash of UK£2.22b as well as receivables valued at UK£1.57b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£3.47b.

Associated British Foods has a very large market capitalization of UK£12.9b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Associated British Foods also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Associated British Foods grew its EBIT by 104% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Associated British Foods can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Associated British Foods 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. During the last three years, Associated British Foods generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

Although Associated British Foods'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£1.48b. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in UK£1.6b. So is Associated British Foods's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Associated British Foods .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.