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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that PriceSmart, Inc. (NASDAQ:PSMT) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does PriceSmart Carry?

The chart below, which you can click on for greater detail, shows that PriceSmart had US$151.7m in debt in May 2024; about the same as the year before. But on the other hand it also has US$230.8m in cash, leading to a US$79.1m net cash position.

How Healthy Is PriceSmart's Balance Sheet?

According to the last reported balance sheet, PriceSmart had liabilities of US$694.4m due within 12 months, and liabilities of US$231.0m due beyond 12 months. Offsetting these obligations, it had cash of US$230.8m as well as receivables valued at US$43.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$651.6m.

PriceSmart has a market capitalization of US$2.77b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, PriceSmart also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, PriceSmart grew its EBIT by 9.1% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PriceSmart'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While PriceSmart 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. Looking at the most recent three years, PriceSmart recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While PriceSmart does have more liabilities than liquid assets, it also has net cash of US$79.1m. And it also grew its EBIT by 9.1% over the last year. So we are not troubled with PriceSmart'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 1 warning sign for PriceSmart that you should be aware of.

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.

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