Edaran Berhad (KLSE:EDARAN) Seems To Use Debt Quite Sensibly

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 can see that Edaran Berhad (KLSE:EDARAN) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Edaran Berhad

What Is Edaran Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Edaran Berhad had RM7.51m of debt in September 2021, down from RM8.10m, one year before. But on the other hand it also has RM13.0m in cash, leading to a RM5.46m net cash position.

A Look At Edaran Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that Edaran Berhad had liabilities of RM13.4m due within 12 months and liabilities of RM8.47m due beyond that. On the other hand, it had cash of RM13.0m and RM5.95m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM2.92m.

Given Edaran Berhad has a market capitalization of RM41.7m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Edaran Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Edaran Berhad made a loss at the EBIT level, last year, it was also good to see that it generated RM5.2m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Edaran Berhad 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Edaran 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 last year, Edaran Berhad actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

We could understand if investors are concerned about Edaran Berhad's liabilities, but we can be reassured by the fact it has has net cash of RM5.46m. The cherry on top was that in converted 188% of that EBIT to free cash flow, bringing in RM9.7m. So we don't think Edaran Berhad's use of debt is risky. 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. For instance, we've identified 3 warning signs for Edaran Berhad (1 is a bit unpleasant) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.