Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 CSP Inc. (NASDAQ:CSPI) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 CSP's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2020 CSP had debt of US$4.06m, up from none in one year. However, it does have US$15.2m in cash offsetting this, leading to net cash of US$11.2m.
How Strong Is CSP's Balance Sheet?
We can see from the most recent balance sheet that CSP had liabilities of US$14.4m falling due within a year, and liabilities of US$10.6m due beyond that. Offsetting these obligations, it had cash of US$15.2m as well as receivables valued at US$15.3m due within 12 months. So it can boast US$5.47m more liquid assets than total liabilities.
This surplus suggests that CSP is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, CSP boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since CSP 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.
Over 12 months, CSP saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.
So How Risky Is CSP?
Statistically speaking companies that lose money are riskier than those that make money. And we do note that CSP had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of US$2.3m and booked a US$1.1m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of US$11.2m. That means it could keep spending at its current rate for more than two years. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. Case in point: We've spotted 5 warning signs for CSP you should be aware of, and 1 of them is a bit concerning.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. 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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