David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Aurelia Metals Limited (ASX:AMI) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Aurelia Metals

What Is Aurelia Metals's Debt?

As you can see below, Aurelia Metals had AU$26.0m of debt at June 2022, down from AU$34.4m a year prior. However, it does have AU$76.7m in cash offsetting this, leading to net cash of AU$50.7m. debt-equity-history-analysis

A Look At Aurelia Metals' Liabilities

According to the last reported balance sheet, Aurelia Metals had liabilities of AU$116.2m due within 12 months, and liabilities of AU$109.1m due beyond 12 months. On the other hand, it had cash of AU$76.7m and AU$27.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$120.9m.

Aurelia Metals has a market capitalization of AU$334.1m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Aurelia Metals also has more cash than debt, so we're pretty confident it can manage its debt safely.



Importantly, Aurelia Metals's EBIT fell a jaw-dropping 97% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Aurelia Metals can strengthen its balance sheet over time. So if you're focused on the future you can check out this freereport showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Aurelia Metals 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. Over the last three years, Aurelia Metals recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although Aurelia Metals's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$50.7m. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in AU$49m. So while Aurelia Metals does not have a great balance sheet, it's certainly not too bad. Even though Aurelia Metals lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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