Does Healthcare Services Group (NASDAQ:HCSG) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Healthcare Services Group, Inc. (NASDAQ:HCSG) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Healthcare Services Group

How Much Debt Does Healthcare Services Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Healthcare Services Group had US$10.0m of debt, an increase on none, over one year. However, its balance sheet shows it holds US$140.1m in cash, so it actually has US$130.1m net cash.

A Look At Healthcare Services Group's Liabilities

According to the last reported balance sheet, Healthcare Services Group had liabilities of US$174.3m due within 12 months, and liabilities of US$125.6m due beyond 12 months. Offsetting these obligations, it had cash of US$140.1m as well as receivables valued at US$324.1m due within 12 months. So it actually has US$164.3m more liquid assets than total liabilities.

This surplus suggests that Healthcare Services Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Healthcare Services Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Healthcare Services Group's saving grace is its low debt levels, because its EBIT has tanked 65% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Healthcare Services Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Healthcare Services Group 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, Healthcare Services Group actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Healthcare Services Group has net cash of US$130.1m, as well as more liquid assets than liabilities. The cherry on top was that in converted 110% of that EBIT to free cash flow, bringing in -US$2.8m. So we don't have any problem with Healthcare Services Group's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Healthcare Services Group (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.