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.' 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. We can see that One Stop Systems, Inc. (NASDAQ:OSS) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does One Stop Systems Carry?
The image below, which you can click on for greater detail, shows that One Stop Systems had debt of US$4.31m at the end of September 2021, a reduction from US$5.48m over a year. But on the other hand it also has US$18.5m in cash, leading to a US$14.2m net cash position.
How Healthy Is One Stop Systems' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that One Stop Systems had liabilities of US$11.6m due within 12 months and no liabilities due beyond that. Offsetting these obligations, it had cash of US$18.5m as well as receivables valued at US$5.81m due within 12 months. So it actually has US$12.7m more liquid assets than total liabilities.
This short term liquidity is a sign that One Stop Systems could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that One Stop Systems has more cash than debt is arguably a good indication that it can manage its debt safely.
Better yet, One Stop Systems grew its EBIT by 166% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if One Stop Systems can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. One Stop Systems 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. Happily for any shareholders, One Stop Systems actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While we empathize with investors who find debt concerning, you should keep in mind that One Stop Systems has net cash of US$14.2m, as well as more liquid assets than liabilities. The cherry on top was that in converted 111% of that EBIT to free cash flow, bringing in US$4.0m. So we don't think One Stop Systems's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for One Stop Systems that you should be aware of before investing here.
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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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.