Here's Why Ocean Bio-Chem (NASDAQ:OBCI) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Ocean Bio-Chem, Inc. (NASDAQ:OBCI) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Ocean Bio-Chem

How Much Debt Does Ocean Bio-Chem Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Ocean Bio-Chem had US$8.19m of debt, an increase on US$4.01m, over one year. But it also has US$10.2m in cash to offset that, meaning it has US$2.03m net cash.

How Healthy Is Ocean Bio-Chem's Balance Sheet?

We can see from the most recent balance sheet that Ocean Bio-Chem had liabilities of US$5.54m falling due within a year, and liabilities of US$8.04m due beyond that. Offsetting this, it had US$10.2m in cash and US$11.1m in receivables that were due within 12 months. So it can boast US$7.75m more liquid assets than total liabilities.

This surplus suggests that Ocean Bio-Chem has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Ocean Bio-Chem boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Ocean Bio-Chem's saving grace is its low debt levels, because its EBIT has tanked 28% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ocean Bio-Chem 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. Ocean Bio-Chem 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, Ocean Bio-Chem's free cash flow amounted to 24% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Ocean Bio-Chem has net cash of US$2.03m, as well as more liquid assets than liabilities. So we are not troubled with Ocean Bio-Chem's debt use. 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. We've identified 3 warning signs with Ocean Bio-Chem (at least 1 which is concerning) , and understanding them should be part of your investment process.

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.