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.' 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 note that Toro Energy Limited (ASX:TOE) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Toro Energy

What Is Toro Energy's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Toro Energy had AU$10.0m of debt in June 2021, down from AU$15.0m, one year before. But on the other hand it also has AU$12.4m in cash, leading to a AU$2.38m net cash position.

How Healthy Is Toro Energy's Balance Sheet?

According to the last reported balance sheet, Toro Energy had liabilities of AU$10.8m due within 12 months, and liabilities of AU$5.8k due beyond 12 months. On the other hand, it had cash of AU$12.4m and AU$223.5k worth of receivables due within a year. So it can boast AU$1.76m more liquid assets than total liabilities.

This state of affairs indicates that Toro Energy's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the AU$109.1m company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Toro Energy boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is Toro Energy's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Since Toro Energy doesn't have significant operating revenue, shareholders must hope it'll sell some fossil fuels, before it runs out of money.

So How Risky Is Toro Energy?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Toro Energy had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of AU$6.4m and booked a AU$6.5m accounting loss. But at least it has AU$2.38m on the balance sheet to spend on growth, near-term. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Toro Energy (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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