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. As with many other companies Ardmore Shipping Corporation (NYSE:ASC) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Ardmore Shipping's Debt?

You can click the graphic below for the historical numbers, but it shows that Ardmore Shipping had US$44.2m of debt in June 2024, down from US$78.9m, one year before. However, its balance sheet shows it holds US$47.4m in cash, so it actually has US$3.22m net cash.

A Look At Ardmore Shipping's Liabilities

Zooming in on the latest balance sheet data, we can see that Ardmore Shipping had liabilities of US$40.7m due within 12 months and liabilities of US$46.6m due beyond that. Offsetting this, it had US$47.4m in cash and US$75.2m in receivables that were due within 12 months. So it can boast US$35.3m more liquid assets than total liabilities.

This surplus suggests that Ardmore Shipping has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Ardmore Shipping has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Ardmore Shipping's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Ardmore Shipping 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Ardmore Shipping 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, Ardmore Shipping produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Ardmore Shipping has US$3.22m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 79% of that EBIT to free cash flow, bringing in US$87m. So we are not troubled with Ardmore Shipping's debt use. 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. For instance, we've identified 2 warning signs for Ardmore Shipping (1 doesn't sit too well with us) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.