Is CLPS Incorporation (NASDAQ:CLPS) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that CLPS Incorporation (NASDAQ:CLPS) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for CLPS Incorporation

What Is CLPS Incorporation's Net Debt?

As you can see below, at the end of December 2022, CLPS Incorporation had US$16.6m of debt, up from US$13.3m a year ago. Click the image for more detail. But it also has US$37.6m in cash to offset that, meaning it has US$21.0m net cash.

How Healthy Is CLPS Incorporation's Balance Sheet?

The latest balance sheet data shows that CLPS Incorporation had liabilities of US$38.1m due within a year, and liabilities of US$3.72m falling due after that. Offsetting these obligations, it had cash of US$37.6m as well as receivables valued at US$45.5m due within 12 months. So it can boast US$41.2m more liquid assets than total liabilities.

This excess liquidity is a great indication that CLPS Incorporation's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, CLPS Incorporation boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for CLPS Incorporation if management cannot prevent a repeat of the 89% cut to EBIT over the last year. 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 CLPS Incorporation 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. CLPS Incorporation 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. Over the last three years, CLPS Incorporation saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case CLPS Incorporation has US$21.0m in net cash and a strong balance sheet. So we are not troubled with CLPS Incorporation's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for CLPS Incorporation you should know about.

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.