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.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We can see that SPAR Group, Inc. (NASDAQ:SGRP) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for SPAR Group
What Is SPAR Group’s Debt?
The image below, which you can click on for greater detail, shows that at June 2021 SPAR Group had debt of US$16.0m, up from US$13.2m in one year. However, its balance sheet shows it holds US$16.7m in cash, so it actually has US$678.0k net cash.
How Strong Is SPAR Group’s Balance Sheet?
The latest balance sheet data shows that SPAR Group had liabilities of US$52.4m due within a year, and liabilities of US$2.15m falling due after that. Offsetting this, it had US$16.7m in cash and US$57.2m in receivables that were due within 12 months. So it actually has US$19.4m more liquid assets than total liabilities.
This surplus strongly suggests that SPAR Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that SPAR Group has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, SPAR Group grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since SPAR Group 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While SPAR Group has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, SPAR Group recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that SPAR Group has net cash of US$678.0k, as well as more liquid assets than liabilities. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in -US$666k. The bottom line is that SPAR Group’s use of debt is absolutely fine. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example – SPAR Group has 3 warning signs we think you should be aware of.
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.
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.
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