Is Caledonian Trust (LON:CNN) Using Too Much Debt?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Caledonian Trust PLC (LON:CNN) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Caledonian Trust

How Much Debt Does Caledonian Trust Carry?

The image below, which you can click on for greater detail, shows that Caledonian Trust had debt of UK£4.38m at the end of December 2021, a reduction from UK£4.95m over a year. On the flip side, it has UK£2.32m in cash leading to net debt of about UK£2.06m.

A Look At Caledonian Trust's Liabilities

According to the last reported balance sheet, Caledonian Trust had liabilities of UK£1.08m due within 12 months, and liabilities of UK£4.02m due beyond 12 months. Offsetting these obligations, it had cash of UK£2.32m as well as receivables valued at UK£121.0k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£2.66m.

Since publicly traded Caledonian Trust shares are worth a total of UK£17.7m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Caledonian Trust's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Given it has no significant operating revenue at the moment, shareholders will be hoping Caledonian Trust can make progress and gain better traction for the business, before it runs low on cash.

Caveat Emptor

Over the last twelve months Caledonian Trust produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at UK£146k. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of UK£1.7m and the profit of UK£591k. So one might argue that there's still a chance it can get things on the right track. 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 Caledonian Trust has 4 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.