We Think Prevas (STO:PREV B) Can Manage Its Debt With Ease

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.' 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 Prevas AB (STO:PREV 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Prevas

How Much Debt Does Prevas Carry?

As you can see below, at the end of March 2022, Prevas had kr94.9m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has kr129.5m in cash, leading to a kr34.6m net cash position.

How Healthy Is Prevas' Balance Sheet?

The latest balance sheet data shows that Prevas had liabilities of kr252.2m due within a year, and liabilities of kr88.0m falling due after that. Offsetting these obligations, it had cash of kr129.5m as well as receivables valued at kr319.4m due within 12 months. So it can boast kr108.7m more liquid assets than total liabilities.

This short term liquidity is a sign that Prevas could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Prevas has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Prevas grew its EBIT by 61% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Prevas 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. While Prevas 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. Over the most recent three years, Prevas recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Prevas has net cash of kr34.6m, as well as more liquid assets than liabilities. And we liked the look of last year's 61% year-on-year EBIT growth. So is Prevas's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with Prevas .

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.