Here's Why XRF Scientific (ASX:XRF) Can Manage Its Debt Responsibly

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 can see that XRF Scientific Limited (ASX:XRF) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for XRF Scientific

How Much Debt Does XRF Scientific Carry?

As you can see below, XRF Scientific had AU$2.93m of debt at June 2024, down from AU$3.59m a year prior. However, its balance sheet shows it holds AU$12.0m in cash, so it actually has AU$9.12m net cash.

How Healthy Is XRF Scientific's Balance Sheet?

According to the last reported balance sheet, XRF Scientific had liabilities of AU$10.4m due within 12 months, and liabilities of AU$2.24m due beyond 12 months. On the other hand, it had cash of AU$12.0m and AU$9.52m worth of receivables due within a year. So it actually has AU$8.88m more liquid assets than total liabilities.

This surplus suggests that XRF Scientific has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that XRF Scientific has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that XRF Scientific grew its EBIT by 15% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if XRF Scientific can strengthen its balance sheet over time. 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. XRF Scientific 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. In the last three years, XRF Scientific's free cash flow amounted to 49% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that XRF Scientific has net cash of AU$9.12m, as well as more liquid assets than liabilities. And it also grew its EBIT by 15% over the last year. So we don't think XRF Scientific's use of debt is risky. We'd be motivated to research the stock further if we found out that XRF Scientific insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.