The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Alpha Metallurgical Resources, Inc. (NYSE:AMR) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

How Much Debt Does Alpha Metallurgical Resources Carry?

The image below, which you can click on for greater detail, shows that Alpha Metallurgical Resources had debt of US$5.10m at the end of December 2023, a reduction from US$6.18m over a year. But it also has US$268.2m in cash to offset that, meaning it has US$263.1m net cash.

A Look At Alpha Metallurgical Resources' Liabilities

Zooming in on the latest balance sheet data, we can see that Alpha Metallurgical Resources had liabilities of US$309.9m due within 12 months and liabilities of US$522.2m due beyond that. Offsetting these obligations, it had cash of US$268.2m as well as receivables valued at US$509.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$54.2m.

Having regard to Alpha Metallurgical Resources' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$4.04b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Alpha Metallurgical Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Alpha Metallurgical Resources's saving grace is its low debt levels, because its EBIT has tanked 46% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Alpha Metallurgical Resources 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Alpha Metallurgical Resources 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 most recent three years, Alpha Metallurgical Resources recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

We could understand if investors are concerned about Alpha Metallurgical Resources's liabilities, but we can be reassured by the fact it has has net cash of US$263.1m. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in US$606m. So we don't have any problem with Alpha Metallurgical Resources's use of debt. 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. Be aware that Alpha Metallurgical Resources is showing 3 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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.