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 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. Importantly, Mitchell Services Limited (ASX:MSV) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Mitchell Services

What Is Mitchell Services's Debt?

You can click the graphic below for the historical numbers, but it shows that Mitchell Services had AU$9.80m of debt in December 2021, down from AU$13.4m, one year before. But it also has AU$10.4m in cash to offset that, meaning it has AU$591.5k net cash.

A Look At Mitchell Services' Liabilities

Zooming in on the latest balance sheet data, we can see that Mitchell Services had liabilities of AU$44.4m due within 12 months and liabilities of AU$25.6m due beyond that. Offsetting these obligations, it had cash of AU$10.4m as well as receivables valued at AU$27.4m due within 12 months. So its liabilities total AU$32.1m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Mitchell Services is worth AU$90.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Mitchell Services also has more cash than debt, so we're pretty confident it can manage its debt safely.

Notably, Mitchell Services made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$1.7m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Mitchell Services'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Mitchell Services 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. During the last year, Mitchell Services burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While Mitchell Services does have more liabilities than liquid assets, it also has net cash of AU$591.5k. Despite the cash, we do find Mitchell Services's conversion of EBIT to free cash flow concerning, so we're not particularly comfortable with the stock. 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 2 warning signs with Mitchell Services , 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.

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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.