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 can see that GR Engineering Services Limited (ASX:GNG) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for GR Engineering Services

What Is GR Engineering Services's Debt?

You can click the graphic below for the historical numbers, but it shows that GR Engineering Services had AU$2.42m of debt in June 2021, down from AU$3.40m, one year before. But it also has AU$69.0m in cash to offset that, meaning it has AU$66.6m net cash. debt-equity-history-analysis

How Healthy Is GR Engineering Services' Balance Sheet?

The latest balance sheet data shows that GR Engineering Services had liabilities of AU$100.0m due within a year, and liabilities of AU$5.72m falling due after that. Offsetting this, it had AU$69.0m in cash and AU$51.9m in receivables that were due within 12 months. So it can boast AU$15.1m more liquid assets than total liabilities.

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



Although GR Engineering Services made a loss at the EBIT level, last year, it was also good to see that it generated AU$31m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if GR Engineering Services 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. GR Engineering Services 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. Happily for any shareholders, GR Engineering Services actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that GR Engineering Services has net cash of AU$66.6m, as well as more liquid assets than liabilities. The cherry on top was that in converted 154% of that EBIT to free cash flow, bringing in AU$48m. So is GR Engineering Services's debt a risk? It doesn't seem so to us. 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. For example - GR Engineering Services has  3 warning signs  we think you should be aware of.

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.

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.

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