Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 can see that AeroVironment, Inc. (NASDAQ:AVAV) does use debt in its business. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is AeroVironment's Debt?

As you can see below, AeroVironment had US$16.8m of debt at July 2024, down from US$128.5m a year prior. However, its balance sheet shows it holds US$81.2m in cash, so it actually has US$64.4m net cash.

A Look At AeroVironment's Liabilities

According to the last reported balance sheet, AeroVironment had liabilities of US$117.4m due within 12 months, and liabilities of US$36.3m due beyond 12 months. Offsetting this, it had US$81.2m in cash and US$255.6m in receivables that were due within 12 months. So it actually has US$183.1m more liquid assets than total liabilities.

This short term liquidity is a sign that AeroVironment could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that AeroVironment has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, AeroVironment grew its EBIT by 34% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine AeroVironment'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. AeroVironment may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last two years, AeroVironment basically broke even on a free cash flow basis. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case AeroVironment has US$64.4m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 34% over the last year. So we don't think AeroVironment's use of debt is risky. 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 example - AeroVironment has 1 warning sign we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.