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Warren Buffett once said, “Volatility is far from synonymous with risk.” It is only natural to consider a company’s balance sheet when examining how risky it is, since debt is often involved when a company collapses. We can see that Potbelly Corporation (NASDAQ:PBPB) does indeed use debt in its business. But is this debt a cause for concern for shareholders?

When is debt dangerous?

Debt helps a company survive until it has trouble paying it back with either fresh capital or free cash flow. A key part of capitalism is the process of “creative destruction,” in which failed companies are mercilessly liquidated by their bankers. A more common (but still costly) situation, however, is that a company must dilute shareholders at a cheap share price just to get debt under control. By replacing dilution, however, debt can be an extremely good tool for companies that need capital to invest in high-return growth. When considering how much debt a company has, you should first look at its cash and debt together.

Check out our latest analysis for Potbelly

How much debt does Potbelly have?

The image below, which you can click on for more details, shows that Potbelly had $5.00 million in debt at the end of March 2024, a reduction of $22.5 million from one year ago, but offsetting this was $12.7 million in cash, resulting in net cash of $7.72 million.

How healthy is Potbelly’s balance sheet?

The most recent balance sheet shows that Potbelly had liabilities of US$67.4 million due within a year, and liabilities of US$146.4 million due beyond that. Offsetting these liabilities, it had cash of US$12.7 million and receivables valued at US$8.38 million due within 12 months. So Potbelly’s liabilities are US$192.7 million more than its cash and near-term receivables combined.

This is a huge level of debt relative to its market capitalization of $233.7 million. Should its lenders demand that the company shore up its balance sheets, shareholders would likely face severe dilution. Despite its sizeable liabilities, Potbelly has net cash flow, so it’s fair to say the company doesn’t have a heavy debt load!

It’s notable that Potbelly’s EBIT soared, growing 67% over the last twelve months. This will make it easier to manage debt. When analyzing debt levels, the balance sheet is the obvious place to start. But it’s future earnings, more than anything, that will determine whether Potbelly can maintain a healthy balance sheet going forward. So if you want to know what the professionals think, you might find this free report on analyst profit forecasts interesting.

However, our final consideration is also important because a company can’t pay off its debt with accounting profits; it needs cold hard cash. While Potbelly 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 understand how quickly it’s building (or burning through) that cash pile. Over the last two years, Potbelly generated solid free cash flow, equal to 58% of its EBIT, which is about what we’d expect. That cold hard cash means the company can reduce its debt if it wants to.

Summarize

Although Potbelly’s balance sheet is not particularly strong due to total liabilities, it is clearly positive to see that it has net cash flow of $7.72 million. And we liked the 67% year-over-year EBIT growth. Therefore, we are not concerned about Potbelly’s debt levels. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks are contained in the balance sheet – quite the opposite. For example, we found that 3 warning signs of potbelly that you should know.

Ultimately, sometimes it’s easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt. 100% freeat the moment.

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This Simply Wall St article is of a general nature. We comment solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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