Here's Why Solid Automotive Berhad (KLSE:SOLID) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Solid Automotive Berhad (KLSE:SOLID) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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.

Check out our latest analysis for Solid Automotive Berhad

How Much Debt Does Solid Automotive Berhad Carry?

The image below, which you can click on for greater detail, shows that at July 2022 Solid Automotive Berhad had debt of RM51.0m, up from RM24.9m in one year. But on the other hand it also has RM57.1m in cash, leading to a RM6.08m net cash position.

How Healthy Is Solid Automotive Berhad's Balance Sheet?

According to the last reported balance sheet, Solid Automotive Berhad had liabilities of RM94.0m due within 12 months, and liabilities of RM17.4m due beyond 12 months. On the other hand, it had cash of RM57.1m and RM88.0m worth of receivables due within a year. So it can boast RM33.6m more liquid assets than total liabilities.

This surplus liquidity suggests that Solid Automotive Berhad's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Solid Automotive Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Solid Automotive Berhad saw its EBIT decline by 9.6% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Solid Automotive Berhad's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Solid Automotive 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. In the last two years, Solid Automotive Berhad's free cash flow amounted to 24% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Solid Automotive Berhad has net cash of RM6.08m, as well as more liquid assets than liabilities. So we don't have any problem with Solid Automotive Berhad's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Solid Automotive Berhad you should be aware of.

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. 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.