Is Warpaint London (LON:W7L) 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.' 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. As with many other companies Warpaint London PLC (LON:W7L) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out the opportunities and risks within the GB Personal Products industry.

How Much Debt Does Warpaint London Carry?

As you can see below, at the end of June 2022, Warpaint London had UK£1.39m of debt, up from UK£20.0k a year ago. Click the image for more detail. However, it does have UK£4.31m in cash offsetting this, leading to net cash of UK£2.93m.

How Healthy Is Warpaint London's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Warpaint London had liabilities of UK£9.28m due within 12 months and liabilities of UK£5.16m due beyond that. On the other hand, it had cash of UK£4.31m and UK£10.2m worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Warpaint London'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£150.8m company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Warpaint London boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Warpaint London grew its EBIT by 240% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Warpaint London'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Warpaint London 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. Over the last three years, Warpaint London actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Warpaint London has net cash of UK£2.93m, as well as more liquid assets than liabilities. The cherry on top was that in converted 152% of that EBIT to free cash flow, bringing in UK£1.0m. So is Warpaint London'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 learn about the 3 warning signs we've spotted with Warpaint London (including 1 which doesn't sit too well with us) .

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.