Does ARC Document Solutions (NYSE:ARC) 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. As with many other companies ARC Document Solutions, Inc. (NYSE:ARC) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out the opportunities and risks within the US Commercial Services industry.

What Is ARC Document Solutions's Debt?

The image below, which you can click on for greater detail, shows that ARC Document Solutions had debt of US$43.8m at the end of June 2022, a reduction from US$48.8m over a year. However, its balance sheet shows it holds US$44.6m in cash, so it actually has US$845.0k net cash.

A Look At ARC Document Solutions' Liabilities

The latest balance sheet data shows that ARC Document Solutions had liabilities of US$72.6m due within a year, and liabilities of US$84.8m falling due after that. On the other hand, it had cash of US$44.6m and US$44.4m worth of receivables due within a year. So its liabilities total US$68.4m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$104.9m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, ARC Document Solutions also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that ARC Document Solutions has boosted its EBIT by 38%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is ARC Document Solutions's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. ARC Document Solutions 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, ARC Document Solutions 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 ARC Document Solutions does have more liabilities than liquid assets, it also has net cash of US$845.0k. The cherry on top was that in converted 270% of that EBIT to free cash flow, bringing in US$26m. So we don't think ARC Document Solutions's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for ARC Document Solutions you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.