AMMO (NASDAQ:POWW) Has A Pretty Healthy Balance Sheet

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, AMMO, Inc. (NASDAQ:POWW) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 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. 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 our latest analysis for AMMO

What Is AMMO's Net Debt?

As you can see below, AMMO had US$5.63m of debt at December 2021, down from US$12.9m a year prior. However, it does have US$27.4m in cash offsetting this, leading to net cash of US$21.8m.

A Look At AMMO's Liabilities

We can see from the most recent balance sheet that AMMO had liabilities of US$35.6m falling due within a year, and liabilities of US$4.46m due beyond that. Offsetting this, it had US$27.4m in cash and US$45.7m in receivables that were due within 12 months. So it can boast US$33.0m more liquid assets than total liabilities.

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

It was also good to see that despite losing money on the EBIT line last year, AMMO turned things around in the last 12 months, delivering and EBIT of US$34m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine AMMO's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. AMMO 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. During the last year, AMMO burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case AMMO has US$21.8m in net cash and a decent-looking balance sheet. So we are not troubled with AMMO's debt use. 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. Case in point: We've spotted 2 warning signs for AMMO you should be aware of, and 1 of them can't be ignored.

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.