Warren Buffett famously said, '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. As with many other companies Circle Property Plc (LON:CRC) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.
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What Is Circle Property's Debt?
The image below, which you can click on for greater detail, shows that Circle Property had debt of UK£21.3m at the end of March 2022, a reduction from UK£61.9m over a year. But it also has UK£25.3m in cash to offset that, meaning it has UK£4.00m net cash.
A Look At Circle Property's Liabilities
Zooming in on the latest balance sheet data, we can see that Circle Property had liabilities of UK£24.0m due within 12 months and liabilities of UK£2.03m due beyond that. On the other hand, it had cash of UK£25.3m and UK£3.63m worth of receivables due within a year. So it can boast UK£2.95m more liquid assets than total liabilities.
This surplus suggests that Circle Property has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Circle Property boasts net cash, so it's fair to say it does not have a heavy debt load!
Shareholders should be aware that Circle Property's EBIT was down 28% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Circle Property 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Circle Property 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. Looking at the most recent three years, Circle Property recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.