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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Alpha and Omega Semiconductor Limited (NASDAQ:AOSL) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Alpha and Omega Semiconductor's Debt?

The image below, which you can click on for greater detail, shows that Alpha and Omega Semiconductor had debt of US$41.2m at the end of March 2024, a reduction from US$66.1m over a year. However, it does have US$174.4m in cash offsetting this, leading to net cash of US$133.2m.

How Strong Is Alpha and Omega Semiconductor's Balance Sheet?

According to the last reported balance sheet, Alpha and Omega Semiconductor had liabilities of US$159.9m due within 12 months, and liabilities of US$105.2m due beyond 12 months. Offsetting these obligations, it had cash of US$174.4m as well as receivables valued at US$14.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$76.4m.

Since publicly traded Alpha and Omega Semiconductor shares are worth a total of US$1.19b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Alpha and Omega Semiconductor boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Alpha and Omega Semiconductor's saving grace is its low debt levels, because its EBIT has tanked 99% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Alpha and Omega Semiconductor'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Alpha and Omega Semiconductor 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. Over the last three years, Alpha and Omega Semiconductor recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Alpha and Omega Semiconductor has US$133.2m in net cash. So while Alpha and Omega Semiconductor does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Alpha and Omega Semiconductor that you should be aware of.

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.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com