Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Like many other companies Corero Network Security plc (LON: CNS) resorts to debt. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
What is Corero Network Security’s debt?
The image below, which you can click on for more details, shows that in December 2021, Corero Network Security had $2.78 million in debt, up from $2.48 million in one year. However, his balance sheet shows that he holds $11.2 million in cash, so he actually has $8.42 million in net cash.
How strong is Corero Network Security’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Corero Network Security had liabilities of US$10.3 million due within 12 months and liabilities of US$3.72 million due beyond. In return, he had $11.2 million in cash and $3.21 million in receivables due within 12 months. So he actually has $423,000 After liquid assets than total liabilities.
Given the size of Corero Network Security, it appears its cash is well balanced against its total liabilities. So it’s highly unlikely that the $75.8 million company will run out of cash, but it’s still worth keeping an eye on the balance sheet. Simply put, the fact that Corero Network Security has more cash than debt is arguably a good indication that it can safely manage its debt.
Notably, Corero Network Security posted a loss in EBIT last year, but improved to a positive EBIT of $1.1 million in the last twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But future earnings, more than anything, will determine Corero Network Security’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecasts.
Finally, a company can only repay its debts with cash, not book profits. Corero Network Security may have net cash on the balance sheet, but it’s always interesting to see how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its needs and its ability to manage debt. Over the past year, Corero Network Security has produced strong free cash flow equivalent to 53% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
While it’s always a good idea to investigate a company’s debt, in this case Corero Network Security has $8.42 million in net cash and a decent balance sheet. We are therefore not concerned about the use of Corero Network Security debt. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 3 warning signs for Corero Network Security you should be aware of, and 1 of them is potentially serious.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.