We Think Arendals Fossekompani (OB:AFK) Can Stay On Top Of Its Debt

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 Arendals Fossekompani ASA (OB:AFK) does use debt in its business. 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 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its 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 at December 2022 Arendals Fossekompani had debt of kr1.13b, up from kr902.9m in one year. But on the other hand it also has kr2.35b in cash, leading to a kr1.22b net cash position.

A Look At Arendals Fossekompani's Liabilities

Zooming in on the latest balance sheet data, we can see that Arendals Fossekompani had liabilities of kr2.87b due within 12 months and liabilities of kr1.18b due beyond that. Offsetting these obligations, it had cash of kr2.35b as well as receivables valued at kr1.38b due within 12 months. So its liabilities total kr322.0m more than the combination of its cash and short-term receivables.

Since publicly traded Arendals Fossekompani shares are worth a total of kr11.7b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Arendals Fossekompani boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Arendals Fossekompani saw its EBIT decline by 3.7% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Arendals Fossekompani will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Arendals Fossekompani 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, Arendals Fossekompani recorded free cash flow worth 60% 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 look at a company's total liabilities, it is very reassuring that Arendals Fossekompani has kr1.22b in net cash. So we don't have any problem with Arendals Fossekompani'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 1 warning sign for Arendals Fossekompani 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.