Is Water Intelligence (LON:WATR) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Water Intelligence plc (LON:WATR) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Water Intelligence

What Is Water Intelligence's Debt?

You can click the graphic below for the historical numbers, but it shows that Water Intelligence had US$8.29m of debt in December 2021, down from US$8.79m, one year before. However, its balance sheet shows it holds US$23.8m in cash, so it actually has US$15.5m net cash.

How Healthy Is Water Intelligence's Balance Sheet?

According to the last reported balance sheet, Water Intelligence had liabilities of US$13.0m due within 12 months, and liabilities of US$18.0m due beyond 12 months. Offsetting this, it had US$23.8m in cash and US$6.45m in receivables that were due within 12 months. So it has liabilities totalling US$734.7k more than its cash and near-term receivables, combined.

This state of affairs indicates that Water Intelligence's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$142.9m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Water Intelligence boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Water Intelligence grew its EBIT by 45% over the last twelve months, and that growth will make it easier to handle its debt. 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 Water Intelligence can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Water Intelligence 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. During the last three years, Water Intelligence generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Water Intelligence has US$15.5m in net cash. And it impressed us with free cash flow of US$3.5m, being 85% of its EBIT. So is Water Intelligence's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Water Intelligence you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.