RM (LON:RM.) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, RM plc (LON:RM.) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for RM

How Much Debt Does RM Carry?

The image below, which you can click on for greater detail, shows that RM had debt of UK£1.25m at the end of November 2020, a reduction from UK£20.5m over a year. However, it does have UK£5.94m in cash offsetting this, leading to net cash of UK£4.69m.

How Healthy Is RM's Balance Sheet?

The latest balance sheet data shows that RM had liabilities of UK£64.6m due within a year, and liabilities of UK£52.4m falling due after that. Offsetting these obligations, it had cash of UK£5.94m as well as receivables valued at UK£34.1m due within 12 months. So its liabilities total UK£77.0m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because RM is worth UK£170.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, RM also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for RM if management cannot prevent a repeat of the 52% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if RM 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While RM 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 most recent three years, RM recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

Although RM'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£4.69m. So although we see some areas for improvement, we're not too worried about RM's balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for RM you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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