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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Skyline Champion Corporation (NYSE:SKY) does carry debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Skyline Champion

What Is Skyline Champion's Net Debt?

As you can see below, Skyline Champion had US$50.3m of debt at July 2022, down from US$68.1m a year prior. But it also has US$463.8m in cash to offset that, meaning it has US$413.5m net cash.

How Strong Is Skyline Champion's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Skyline Champion had liabilities of US$370.2m due within 12 months and liabilities of US$59.5m due beyond that. On the other hand, it had cash of US$463.8m and US$128.6m worth of receivables due within a year. So it can boast US$162.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Skyline Champion could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Skyline Champion has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Skyline Champion grew its EBIT by 183% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 Skyline Champion 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 company can only pay off debt with cold hard cash, not accounting profits. Skyline Champion 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. Over the most recent three years, Skyline Champion recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Skyline Champion has US$413.5m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 183% over the last year. So is Skyline Champion'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. We've identified 2 warning signs with Skyline Champion , 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.