Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Elmo Software Limited (ASX:ELO) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. 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. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for Elmo Software
What Is Elmo Software's Debt?
The image below, which you can click on for greater detail, shows that at December 2021 Elmo Software had debt of AU$40.5m, up from none in one year. However, it does have AU$58.4m in cash offsetting this, leading to net cash of AU$17.9m.
A Look At Elmo Software's Liabilities
The latest balance sheet data shows that Elmo Software had liabilities of AU$89.8m due within a year, and liabilities of AU$78.2m falling due after that. Offsetting these obligations, it had cash of AU$58.4m as well as receivables valued at AU$21.2m due within 12 months. So its liabilities total AU$88.4m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Elmo Software has a market capitalization of AU$383.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Elmo Software boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Elmo Software 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.