Here's Why Art's-Way Manufacturing (NASDAQ:ARTW) Can Afford Some Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Art's-Way Manufacturing Co., Inc. (NASDAQ:ARTW) makes use of debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

Check out our latest analysis for Art's-Way Manufacturing

How Much Debt Does Art's-Way Manufacturing Carry?

The image below, which you can click on for greater detail, shows that at August 2021 Art's-Way Manufacturing had debt of US$7.04m, up from US$5.84m in one year. Net debt is about the same, since the it doesn't have much cash.

How Strong Is Art's-Way Manufacturing's Balance Sheet?

The latest balance sheet data shows that Art's-Way Manufacturing had liabilities of US$8.67m due within a year, and liabilities of US$2.70m falling due after that. On the other hand, it had cash of US$108.0k and US$2.96m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$8.30m.

Art's-Way Manufacturing has a market capitalization of US$17.2m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But it is Art's-Way Manufacturing'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.

Over 12 months, Art's-Way Manufacturing made a loss at the EBIT level, and saw its revenue drop to US$23m, which is a fall of 5.2%. That's not what we would hope to see.

Caveat Emptor

Importantly, Art's-Way Manufacturing had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping US$2.3m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through US$2.3m of cash over the last year. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Art's-Way Manufacturing you should be aware of, and 2 of them are significant.

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.