Here's Why RAVE Restaurant Group (NASDAQ:RAVE) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, RAVE Restaurant Group, Inc. (NASDAQ:RAVE) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 RAVE Restaurant Group

What Is RAVE Restaurant Group's Net Debt?

As you can see below, RAVE Restaurant Group had US$1.70m of debt at September 2021, down from US$2.21m a year prior. However, its balance sheet shows it holds US$7.88m in cash, so it actually has US$6.17m net cash.

A Look At RAVE Restaurant Group's Liabilities

The latest balance sheet data shows that RAVE Restaurant Group had liabilities of US$3.89m due within a year, and liabilities of US$2.63m falling due after that. Offsetting this, it had US$7.88m in cash and US$1.40m in receivables that were due within 12 months. So it actually has US$2.76m 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. Succinctly put, RAVE Restaurant Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that RAVE Restaurant Group grew its EBIT by 180% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since RAVE Restaurant Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While RAVE Restaurant Group 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, RAVE Restaurant Group reported free cash flow worth 13% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that RAVE Restaurant Group has net cash of US$6.17m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 180% over the last year. So we don't think RAVE Restaurant Group's use of debt is risky. 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. Be aware that RAVE Restaurant Group is showing 2 warning signs in our investment analysis , 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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