Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, XRF Scientific Limited (ASX:XRF) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, 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.
How Much Debt Does XRF Scientific Carry?
The image below, which you can click on for greater detail, shows that at June 2022 XRF Scientific had debt of AU$5.41m, up from AU$4.61m in one year. But on the other hand it also has AU$6.65m in cash, leading to a AU$1.24m net cash position.
How Strong Is XRF Scientific's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that XRF Scientific had liabilities of AU$9.66m due within 12 months and liabilities of AU$2.55m due beyond that. On the other hand, it had cash of AU$6.65m and AU$6.23m worth of receivables due within a year. So it actually has AU$667.5k more liquid assets than total liabilities.
Having regard to XRF Scientific's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the AU$97.8m company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that XRF Scientific has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that XRF Scientific has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. 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 XRF Scientific'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 company can only pay off debt with cold hard cash, not accounting profits. While XRF Scientific 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. During the last three years, XRF Scientific produced sturdy free cash flow equating to 54% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that XRF Scientific has net cash of AU$1.24m, as well as more liquid assets than liabilities. And we liked the look of last year's 39% year-on-year EBIT growth. So we don't think XRF Scientific's use of debt is risky. 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. Be aware that XRF Scientific is showing 2 warning signs in our investment analysis , you should know about...
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.
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