Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Aurelia Metals Limited (ASX:AMI) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Aurelia Metals

How Much Debt Does Aurelia Metals Carry?

The image below, which you can click on for greater detail, shows that at June 2021 Aurelia Metals had debt of AU$34.4m, up from none in one year. But on the other hand it also has AU$74.5m in cash, leading to a AU$40.1m net cash position.

How Strong Is Aurelia Metals' Balance Sheet?

The latest balance sheet data shows that Aurelia Metals had liabilities of AU$84.9m due within a year, and liabilities of AU$150.3m falling due after that. Offsetting these obligations, it had cash of AU$74.5m as well as receivables valued at AU$26.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$133.7m.

While this might seem like a lot, it is not so bad since Aurelia Metals has a market capitalization of AU$389.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Aurelia Metals boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Aurelia Metals grew its EBIT by 108% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Aurelia Metals 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. While Aurelia Metals 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, Aurelia Metals produced sturdy free cash flow equating to 56% 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

While Aurelia Metals does have more liabilities than liquid assets, it also has net cash of AU$40.1m. And we liked the look of last year's 108% year-on-year EBIT growth. So we don't think Aurelia Metals's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Aurelia Metals 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.

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.

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