Is Arco Platform (NASDAQ:ARCE) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Arco Platform Limited (NASDAQ:ARCE) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Arco Platform

What Is Arco Platform's Debt?

As you can see below, Arco Platform had R$308.7m of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds R$865.6m in cash, so it actually has R$556.9m net cash.

A Look At Arco Platform's Liabilities

We can see from the most recent balance sheet that Arco Platform had liabilities of R$1.23b falling due within a year, and liabilities of R$1.14b due beyond that. Offsetting this, it had R$865.6m in cash and R$431.2m in receivables that were due within 12 months. So its liabilities total R$1.07b more than the combination of its cash and short-term receivables.

Since publicly traded Arco Platform shares are worth a total of R$5.67b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Arco Platform also has more cash than debt, so we're pretty confident it can manage its debt safely.

If Arco Platform can keep growing EBIT at last year's rate of 18% over the last year, then it will find its debt load easier to manage. 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 Arco Platform can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Arco Platform has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Arco Platform recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While Arco Platform does have more liabilities than liquid assets, it also has net cash of R$556.9m. And it impressed us with its EBIT growth of 18% over the last year. So although we see some areas for improvement, we're not too worried about Arco Platform's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Arco Platform you should know about.

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.

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.

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