Does Elmo Software (ASX:ELO) use debt in a risky way?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Elmo Software Limited (ASX:ELO) has debt on its balance sheet. But does this debt worry shareholders?

When is debt a problem?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

Check out our latest analysis for Elmo Software

What is Elmo Software’s net debt?

You can click on the graph below for historical figures, but it shows that as of December 2021, Elmo Software had A$40.5 million in debt, an increase of none, year over year. However, he has A$58.4 million in cash to offset this, which translates to a net cash of A$17.9 million.

ASX:ELO Debt to Equity April 27, 2022

A Look at Elmo Software’s Responsibilities

According to the latest published balance sheet, Elmo Software had liabilities of A$89.8 million due within 12 months and liabilities of A$78.2 million due beyond 12 months. As compensation for these obligations, it had cash of A$58.4 million and receivables valued at A$21.2 million due within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables of A$88.4 million.

While that might sound like a lot, it’s not too bad since Elmo Software has a market capitalization of A$306.4 million, so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution. Despite its notable liabilities, Elmo Software has a net cash position, so it’s fair to say that it doesn’t have a lot of debt! When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Elmo Software can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Last year, Elmo Software was not profitable in terms of EBIT, but managed to increase its turnover by 43%, to 82 million Australian dollars. The shareholders probably have their fingers crossed that she can make a profit.

So how risky is Elmo software?

We have no doubt that loss-making companies are, in general, more risky than profitable companies. And the fact is that over the past twelve months, Elmo Software has been losing money in earnings before interest and taxes (EBIT). Indeed, during this period, he spent A$26 million in cash and suffered a loss of A$66 million. While this makes the business a bit risky, it’s important to remember that it has a net cash position of A$17.9 million. This pot means that the company can continue to spend on growth for at least two years, at current rates. With very solid revenue growth over the past year, Elmo Software could be on the road to profitability. By investing before these profits, shareholders take on more risk in the hope of greater rewards. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. To this end, you should be aware of the 2 warning signs we spotted with Elmo Software.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.