Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Brady Corporation (NYSE:BRC) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Brady's Debt?

You can click the graphic below for the historical numbers, but it shows that Brady had US$48.1m of debt in January 2024, down from US$77.3m, one year before. However, it does have US$143.9m in cash offsetting this, leading to net cash of US$95.8m.

How Healthy Is Brady's Balance Sheet?

We can see from the most recent balance sheet that Brady had liabilities of US$237.3m falling due within a year, and liabilities of US$131.6m due beyond that. On the other hand, it had cash of US$143.9m and US$185.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$39.4m.

This state of affairs indicates that Brady's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$2.94b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Brady boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Brady grew its EBIT by 16% last year, making its debt load easier to handle. 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 Brady 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 Brady 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. During the last three years, Brady produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. 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 Brady's liabilities, but we can be reassured by the fact it has has net cash of US$95.8m. So is Brady'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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Brady you should know about.

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.