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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Tree House Education & Accessories Limited (NSE:TREEHOUSE) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Tree House Education & Accessories's Net Debt?
As you can see below, at the end of September 2021, Tree House Education & Accessories had ₹364.8m of debt, up from ₹312.6m a year ago. Click the image for more detail. On the flip side, it has ₹19.8m in cash leading to net debt of about ₹345.0m.
How Healthy Is Tree House Education & Accessories' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Tree House Education & Accessories had liabilities of ₹499.7m due within 12 months and no liabilities due beyond that. Offsetting these obligations, it had cash of ₹19.8m as well as receivables valued at ₹206.4m due within 12 months. So its liabilities total ₹273.5m more than the combination of its cash and short-term receivables.
Tree House Education & Accessories has a market capitalization of ₹513.7m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tree House Education & Accessories will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Over 12 months, Tree House Education & Accessories reported revenue of ₹72m, which is a gain of 260%, although it did not report any earnings before interest and tax. When it comes to revenue growth, that's like nailing the game winning 3-pointer!
Even though Tree House Education & Accessories managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping ₹294m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of ₹438m. So to be blunt we do think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Tree House Education & Accessories (2 are a bit unpleasant) you should be aware of.
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.
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.