Here's Why Arendals Fossekompani (OB:AFK) 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, Arendals Fossekompani ASA (OB:AFK) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Arendals Fossekompani

What Is Arendals Fossekompani's Net Debt?

The image below, which you can click on for greater detail, shows that Arendals Fossekompani had debt of kr1.22b at the end of September 2021, a reduction from kr1.48b over a year. However, its balance sheet shows it holds kr2.48b in cash, so it actually has kr1.26b net cash.

A Look At Arendals Fossekompani's Liabilities

According to the last reported balance sheet, Arendals Fossekompani had liabilities of kr1.82b due within 12 months, and liabilities of kr1.03b due beyond 12 months. On the other hand, it had cash of kr2.48b and kr1.36b worth of receivables due within a year. So it actually has kr973.0m more liquid assets than total liabilities.

This surplus suggests that Arendals Fossekompani has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Arendals Fossekompani 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 Arendals Fossekompani has boosted its EBIT by 82%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Arendals Fossekompani's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Arendals Fossekompani 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. In the last three years, Arendals Fossekompani's free cash flow amounted to 22% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Arendals Fossekompani has kr1.26b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 82% over the last year. So we don't think Arendals Fossekompani's use of debt is risky. 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. For example Arendals Fossekompani has 3 warning signs (and 1 which can't be ignored) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.