David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Sigma Lithium Corporation (NASDAQ:SGML) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Sigma Lithium's Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Sigma Lithium had debt of CA$170.9m, up from CA$77.4m in one year. However, it does have CA$64.4m in cash offsetting this, leading to net debt of about CA$106.5m.

How Healthy Is Sigma Lithium's Balance Sheet?

According to the last reported balance sheet, Sigma Lithium had liabilities of CA$122.4m due within 12 months, and liabilities of CA$150.6m due beyond 12 months. Offsetting these obligations, it had cash of CA$64.4m as well as receivables valued at CA$47.4m due within 12 months. So it has liabilities totalling CA$161.2m more than its cash and near-term receivables, combined.

Of course, Sigma Lithium has a market capitalization of CA$2.60b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Sigma Lithium's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

While it hasn't made a profit, at least Sigma Lithium booked its first revenue as a publicly listed company, in the last twelve months.

Caveat Emptor

Importantly, Sigma Lithium had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CA$22m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CA$100m in negative free cash flow over the last twelve months. So to be blunt we think it 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 Sigma Lithium you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.