These 4 Measures Indicate That Arco Platform (NASDAQ:ARCE) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Arco Platform Limited (NASDAQ:ARCE) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for Arco Platform

What Is Arco Platform's Net Debt?

As you can see below, Arco Platform had R$309.6m of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. However, it does have R$1.02b in cash offsetting this, leading to net cash of R$708.1m.

How Strong Is Arco Platform's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Arco Platform had liabilities of R$1.23b due within 12 months and liabilities of R$1.23b due beyond that. On the other hand, it had cash of R$1.02b and R$548.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$898.3m.

Given Arco Platform has a market capitalization of R$8.78b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Arco Platform boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Arco Platform grew its EBIT by 83% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Arco Platform's ability to maintain a healthy balance sheet going forward. 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. 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. Considering the last three years, Arco Platform actually recorded a cash outflow, overall. 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$708.1m. And we liked the look of last year's 83% year-on-year EBIT growth. So we are not troubled with Arco Platform's debt use. 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. For example, we've discovered 1 warning sign for Arco Platform that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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