Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Allergy Therapeutics plc (LON:AGY) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Allergy Therapeutics

What Is Allergy Therapeutics's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Allergy Therapeutics had debt of UK£3.82m, up from UK£1.98m in one year. But on the other hand it also has UK£48.3m in cash, leading to a UK£44.5m net cash position.

How Strong Is Allergy Therapeutics' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Allergy Therapeutics had liabilities of UK£16.4m due within 12 months and liabilities of UK£23.9m due beyond that. Offsetting these obligations, it had cash of UK£48.3m as well as receivables valued at UK£10.8m due within 12 months. So it actually has UK£18.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Allergy Therapeutics could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Allergy Therapeutics boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Allergy Therapeutics grew its EBIT by 3,153% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Allergy Therapeutics can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Allergy Therapeutics 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 two years, Allergy Therapeutics actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Allergy Therapeutics has UK£44.5m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of UK£8.0m, being 216% of its EBIT. So we don't think Allergy Therapeutics'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. We've identified 1 warning sign with Allergy Therapeutics , and understanding them should be part of your investment process.

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. 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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