Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies RAVE Restaurant Group, Inc. (NASDAQ:RAVE) makes use of debt. But is this debt a concern to shareholders?
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 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.
What Is RAVE Restaurant Group's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 RAVE Restaurant Group had US$2.21m of debt, an increase on US$1.53m, over one year. However, its balance sheet shows it holds US$2.94m in cash, so it actually has US$723.0k net cash.
A Look At RAVE Restaurant Group's Liabilities
Zooming in on the latest balance sheet data, we can see that RAVE Restaurant Group had liabilities of US$2.51m due within 12 months and liabilities of US$6.44m due beyond that. Offsetting this, it had US$2.94m in cash and US$1.50m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.52m.
RAVE Restaurant Group has a market capitalization of US$16.2m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, RAVE Restaurant Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Importantly, RAVE Restaurant Group's EBIT fell a jaw-dropping 73% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is RAVE Restaurant Group's earnings that will influence how the balance sheet holds up in the future. 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. 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. During the last three years, RAVE Restaurant Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While RAVE Restaurant Group does have more liabilities than liquid assets, it also has net cash of US$723.0k. Despite the cash, we do find RAVE Restaurant Group's EBIT growth rate concerning, so we're not particularly comfortable with the stock. 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. To that end, you should be aware of the 3 warning signs we've spotted with RAVE Restaurant Group .
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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