Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, ARC Document Solutions, Inc. (NYSE:ARC) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is ARC Document Solutions's Debt?
As you can see below, ARC Document Solutions had US$46.3m of debt at December 2021, down from US$55.0m a year prior. However, it does have US$55.9m in cash offsetting this, leading to net cash of US$9.68m.
How Strong Is ARC Document Solutions' Balance Sheet?
We can see from the most recent balance sheet that ARC Document Solutions had liabilities of US$75.5m falling due within a year, and liabilities of US$89.5m due beyond that. Offsetting this, it had US$55.9m in cash and US$39.4m in receivables that were due within 12 months. So its liabilities total US$69.6m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because ARC Document Solutions is worth US$152.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, ARC Document Solutions boasts net cash, so it's fair to say it does not have a heavy debt load!
Another good sign is that ARC Document Solutions has been able to increase its EBIT by 22% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is ARC Document Solutions'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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. Happily for any shareholders, ARC Document Solutions actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While ARC Document Solutions does have more liabilities than liquid assets, it also has net cash of US$9.68m. And it impressed us with free cash flow of US$32m, being 284% of its EBIT. So we don't think ARC Document Solutions's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with ARC Document Solutions , and understanding them should be part of your investment process.
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.