Here's Why Potbelly (NASDAQ:PBPB) Can Manage Its Debt Responsibly

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. We note that Potbelly Corporation (NASDAQ:PBPB) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Potbelly

What Is Potbelly's Net Debt?

The image below, which you can click on for greater detail, shows that Potbelly had debt of US$22.5m at the end of March 2023, a reduction from US$24.3m over a year. However, it does have US$25.6m in cash offsetting this, leading to net cash of US$3.05m.

How Strong Is Potbelly's Balance Sheet?

We can see from the most recent balance sheet that Potbelly had liabilities of US$65.8m falling due within a year, and liabilities of US$180.7m due beyond that. On the other hand, it had cash of US$25.6m and US$7.26m worth of receivables due within a year. So it has liabilities totalling US$213.7m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of US$244.0m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Potbelly also has more cash than debt, so we're pretty confident it can manage its debt safely.

Notably, Potbelly made a loss at the EBIT level, last year, but improved that to positive EBIT of US$7.9m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Potbelly 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Potbelly 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 year, Potbelly actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Potbelly's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$3.05m. The cherry on top was that in converted 117% of that EBIT to free cash flow, bringing in US$9.2m. So we don't have any problem with Potbelly's use of debt. 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. Case in point: We've spotted 1 warning sign for Potbelly you should be aware of.

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.