Is RAVE Restaurant Group (NASDAQ:RAVE) Using Too Much Debt?

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 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 RAVE Restaurant Group, Inc. (NASDAQ:RAVE) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for RAVE Restaurant Group

What Is RAVE Restaurant Group's Debt?

As you can see below, at the end of December 2020, RAVE Restaurant Group had US$2.22m of debt, up from US$1.54m a year ago. Click the image for more detail. However, its balance sheet shows it holds US$6.29m in cash, so it actually has US$4.07m 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$2.25m falling due within a year, and liabilities of US$6.21m due beyond that. Offsetting this, it had US$6.29m in cash and US$1.93m in receivables that were due within 12 months. So it has liabilities totalling US$250.0k more than its cash and near-term receivables, combined.

This state of affairs indicates that RAVE Restaurant Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$25.6m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, RAVE Restaurant Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that RAVE Restaurant Group's EBIT was down 76% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 company can only pay off debt with cold hard cash, not accounting profits. 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 saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that RAVE Restaurant Group has US$4.07m in net cash. Despite its cash we think that RAVE Restaurant Group seems to struggle to grow its EBIT, so we are wary of the stock. There's no doubt that we learn most about debt from the balance sheet. 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 3 warning signs for RAVE Restaurant Group 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.

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