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. Importantly, Smith-Midland Corporation (NASDAQ:SMID) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

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What Is Smith-Midland's Debt?

The image below, which you can click on for greater detail, shows that Smith-Midland had debt of US$6.87m at the end of March 2022, a reduction from US$7.43m over a year. However, its balance sheet shows it holds US$14.8m in cash, so it actually has US$7.95m net cash.

A Look At Smith-Midland's Liabilities

The latest balance sheet data shows that Smith-Midland had liabilities of US$14.6m due within a year, and liabilities of US$10.2m falling due after that. On the other hand, it had cash of US$14.8m and US$12.9m worth of receivables due within a year. So it can boast US$2.93m more liquid assets than total liabilities.

This short term liquidity is a sign that Smith-Midland could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Smith-Midland has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Smith-Midland's load is not too heavy, because its EBIT was down 71% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Smith-Midland will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Smith-Midland 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. In the last three years, Smith-Midland's free cash flow amounted to 44% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.