Does RAVE Restaurant Group (NASDAQ:RAVE) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies RAVE Restaurant Group, Inc. (NASDAQ:RAVE) makes use of debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for RAVE Restaurant Group

What Is RAVE Restaurant Group's Debt?

As you can see below, at the end of March 2021, RAVE Restaurant Group had US$2.23m of debt, up from US$1.54m a year ago. Click the image for more detail. But it also has US$6.49m in cash to offset that, meaning it has US$4.26m net cash.

How Healthy Is RAVE Restaurant Group's Balance Sheet?

We can see from the most recent balance sheet that RAVE Restaurant Group had liabilities of US$2.18m falling due within a year, and liabilities of US$5.51m due beyond that. Offsetting this, it had US$6.49m in cash and US$2.23m in receivables that were due within 12 months. So it actually has US$1.03m more liquid assets than total liabilities.

This surplus suggests that RAVE Restaurant Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that RAVE Restaurant Group has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact RAVE Restaurant Group's saving grace is its low debt levels, because its EBIT has tanked 57% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since RAVE Restaurant Group will need earnings to service that debt. 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. RAVE Restaurant Group 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. In the last three years, RAVE Restaurant Group created free cash flow amounting to 4.1% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case RAVE Restaurant Group has US$4.26m in net cash and a decent-looking balance sheet. So while RAVE Restaurant Group does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 5 warning signs with RAVE Restaurant Group (at least 2 which don't sit too well with us) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.
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