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 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. We note that Electro Optic Systems Holdings Limited (ASX:EOS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Electro Optic Systems Holdings

How Much Debt Does Electro Optic Systems Holdings Carry?

The image below, which you can click on for greater detail, shows that at December 2021 Electro Optic Systems Holdings had debt of AU$34.4m, up from none in one year. But it also has AU$59.3m in cash to offset that, meaning it has AU$24.8m net cash. debt-equity-history-analysis

A Look At Electro Optic Systems Holdings' Liabilities

The latest balance sheet data shows that Electro Optic Systems Holdings had liabilities of AU$104.2m due within a year, and liabilities of AU$32.1m falling due after that. On the other hand, it had cash of AU$59.3m and AU$133.7m worth of receivables due within a year. So it actually has AU$56.6m more liquid assets than total liabilities.

This surplus suggests that Electro Optic Systems Holdings is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Electro Optic Systems Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Electro Optic Systems Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.



Over 12 months, Electro Optic Systems Holdings reported revenue of AU$212m, which is a gain of 18%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

So How Risky Is Electro Optic Systems Holdings?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Electro Optic Systems Holdings lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through AU$28m of cash and made a loss of AU$16m. Given it only has net cash of AU$24.8m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted  1 warning sign for Electro Optic Systems Holdings you should be aware of.

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. 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.