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. Importantly, Prada S.p.A. (HKG:1913) does carry debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Prada

What Is Prada's Debt?

You can click the graphic below for the historical numbers, but it shows that Prada had €486.7m of debt in June 2023, down from €608.0m, one year before. But on the other hand it also has €766.3m in cash, leading to a €279.5m net cash position.

How Healthy Is Prada's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Prada had liabilities of €1.33b due within 12 months and liabilities of €2.37b due beyond that. On the other hand, it had cash of €766.3m and €399.6m worth of receivables due within a year. So it has liabilities totalling €2.54b more than its cash and near-term receivables, combined.

Of course, Prada has a titanic market capitalization of €13.8b, 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. Despite its noteworthy liabilities, Prada boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Prada has boosted its EBIT by 53%, thus reducing the spectre of future debt repayments. 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 Prada's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Prada 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. Over the last three years, Prada actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While Prada does have more liabilities than liquid assets, it also has net cash of €279.5m. And it impressed us with free cash flow of €840m, being 123% of its EBIT. So is Prada's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Prada, you may well want to click here to check an interactive graph of its earnings per share history.

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.