Volvo Car AB (publ.) (STO:VOLCAR B) Takes On Some Risk With Its Use Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Volvo Car AB (publ.) (STO:VOLCAR B) does have debt on its balance sheet. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Volvo Car AB (publ.)

How Much Debt Does Volvo Car AB (publ.) Carry?

The chart below, which you can click on for greater detail, shows that Volvo Car AB (publ.) had kr29.6b in debt in June 2024; about the same as the year before. But on the other hand it also has kr43.9b in cash, leading to a kr14.4b net cash position.

How Healthy Is Volvo Car AB (publ.)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Volvo Car AB (publ.) had liabilities of kr177.1b due within 12 months and liabilities of kr69.2b due beyond that. On the other hand, it had cash of kr43.9b and kr28.2b worth of receivables due within a year. So its liabilities total kr174.2b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the kr73.9b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Volvo Car AB (publ.) would probably need a major re-capitalization if its creditors were to demand repayment. Given that Volvo Car AB (publ.) has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

In addition to that, we're happy to report that Volvo Car AB (publ.) has boosted its EBIT by 52%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Volvo Car AB (publ.) can strengthen its balance sheet over time. 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. Volvo Car AB (publ.) 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 three years, Volvo Car AB (publ.) reported free cash flow worth 14% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

Although Volvo Car AB (publ.)'s balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of kr14.4b. And we liked the look of last year's 52% year-on-year EBIT growth. So while Volvo Car AB (publ.) does not have a great balance sheet, it's certainly not too bad. Given our hesitation about the stock, it would be good to know if Volvo Car AB (publ.) insiders have sold any shares recently. You click here to find out if insiders have sold recently.

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.