Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 The Hour Glass Limited (SGX:AGS) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hour Glass

What Is Hour Glass's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Hour Glass had debt of S$111.0m, up from S$105.1m in one year. But on the other hand it also has S$327.3m in cash, leading to a S$216.3m net cash position.

How Strong Is Hour Glass' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hour Glass had liabilities of S$242.1m due within 12 months and liabilities of S$83.6m due beyond that. Offsetting these obligations, it had cash of S$327.3m as well as receivables valued at S$15.7m due within 12 months. So it can boast S$17.3m more liquid assets than total liabilities.

This state of affairs indicates that Hour Glass' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the S$1.53b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Hour Glass has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Hour Glass grew its EBIT by 82% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hour Glass's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hour Glass 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. Happily for any shareholders, Hour Glass actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hour Glass has net cash of S$216.3m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of S$208m, being 116% of its EBIT. So is Hour Glass's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Hour Glass , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.