Warren Buffett famously said, '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. We note that Avon Rubber p.l.c. (LON:AVON) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. 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.

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How Much Debt Does Avon Rubber Carry?

The image below, which you can click on for greater detail, shows that Avon Rubber had debt of US$12.9m at the end of March 2021, a reduction from US$66.7m over a year. But on the other hand it also has US$190.1m in cash, leading to a US$177.2m net cash position.

How Healthy Is Avon Rubber's Balance Sheet?

According to the last reported balance sheet, Avon Rubber had liabilities of US$69.7m due within 12 months, and liabilities of US$140.8m due beyond 12 months. On the other hand, it had cash of US$190.1m and US$54.3m worth of receivables due within a year. So it actually has US$33.9m more liquid assets than total liabilities.

This surplus suggests that Avon Rubber has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Avon Rubber boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Avon Rubber grew its EBIT by 759% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Avon Rubber's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Avon Rubber may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Avon Rubber recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.