We Think XRF Scientific (ASX:XRF) Can Manage Its Debt With Ease

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that XRF Scientific Limited (ASX:XRF) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for XRF Scientific

How Much Debt Does XRF Scientific Carry?

The image below, which you can click on for greater detail, shows that XRF Scientific had debt of AU$4.49m at the end of December 2021, a reduction from AU$4.73m over a year. But it also has AU$4.64m in cash to offset that, meaning it has AU$148.2k net cash.

How Strong Is XRF Scientific's Balance Sheet?

According to the last reported balance sheet, XRF Scientific had liabilities of AU$7.59m due within 12 months, and liabilities of AU$2.82m due beyond 12 months. Offsetting this, it had AU$4.64m in cash and AU$4.89m in receivables that were due within 12 months. So it has liabilities totalling AU$882.6k more than its cash and near-term receivables, combined.

Having regard to XRF Scientific's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the AU$85.6m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, XRF Scientific also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, XRF Scientific grew its EBIT by 67% over the last twelve months, and that growth will make it easier to handle its debt. 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 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. 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. During the last three years, XRF Scientific produced sturdy free cash flow equating to 70% 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.

Summing up

We could understand if investors are concerned about XRF Scientific's liabilities, but we can be reassured by the fact it has has net cash of AU$148.2k. And we liked the look of last year's 67% 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. For example - XRF Scientific has 2 warning signs we think 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.