Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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 Associated British Foods plc (LON:ABF) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Associated British Foods

How Much Debt Does Associated British Foods Carry?

The image below, which you can click on for greater detail, shows that Associated British Foods had debt of UK£574.0m at the end of September 2019, a reduction from UK£764.0m over a year. But it also has UK£1.52b in cash to offset that, meaning it has UK£950.0m net cash.

How Strong Is Associated British Foods's Balance Sheet?

According to the last reported balance sheet, Associated British Foods had liabilities of UK£3.07b due within 12 months, and liabilities of UK£1.14b due beyond 12 months. Offsetting this, it had UK£1.52b in cash and UK£1.27b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£1.42b.

Of course, Associated British Foods has a titanic market capitalization of UK£20.8b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Associated British Foods also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Associated British Foods grew its EBIT by 3.0% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Associated British Foods'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.