Does Three-A Resources Berhad (KLSE:3A) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Three-A Resources Berhad (KLSE:3A) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Three-A Resources Berhad

What Is Three-A Resources Berhad's Net Debt?

As you can see below, Three-A Resources Berhad had RM8.01m of debt at December 2021, down from RM12.7m a year prior. However, it does have RM55.6m in cash offsetting this, leading to net cash of RM47.6m.

How Healthy Is Three-A Resources Berhad's Balance Sheet?

The latest balance sheet data shows that Three-A Resources Berhad had liabilities of RM46.5m due within a year, and liabilities of RM18.8m falling due after that. On the other hand, it had cash of RM55.6m and RM110.5m worth of receivables due within a year. So it actually has RM100.8m more liquid assets than total liabilities.

This surplus suggests that Three-A Resources Berhad is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Three-A Resources Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Three-A Resources Berhad has boosted its EBIT by 48%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Three-A Resources Berhad'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Three-A Resources Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Three-A Resources Berhad recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Three-A Resources Berhad has RM47.6m in net cash and a decent-looking balance sheet. And we liked the look of last year's 48% year-on-year EBIT growth. The bottom line is that we do not find Three-A Resources Berhad's debt levels at all concerning. 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 instance, we've identified 3 warning signs for Three-A Resources Berhad (1 can't be ignored) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.