Warren Buffett famously said, '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. As with many other companies Energy One Limited (ASX:EOL) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Energy One

How Much Debt Does Energy One Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Energy One had AU$2.84m of debt, an increase on AU$234.0k, over one year. However, its balance sheet shows it holds AU$3.73m in cash, so it actually has AU$887.0k net cash. debt-equity-history-analysis

A Look At Energy One's Liabilities

Zooming in on the latest balance sheet data, we can see that Energy One had liabilities of AU$10.5m due within 12 months and liabilities of AU$8.97m due beyond that. On the other hand, it had cash of AU$3.73m and AU$3.90m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$11.8m.

Of course, Energy One has a market capitalization of AU$164.7m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Energy One boasts net cash, so it's fair to say it does not have a heavy debt load!



And we also note warmly that Energy One grew its EBIT by 10% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Energy One's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Energy One 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. During the last three years, Energy One produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Energy One has AU$887.0k in net cash. So we don't think Energy One's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted  2 warning signs for Energy One  you should know about.

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.