XRF Scientific (ASX:XRF) Seems To Use Debt Rather Sparingly

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. As with many other companies XRF Scientific Limited (ASX:XRF) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Our analysis indicates that XRF is potentially undervalued!

How Much Debt Does XRF Scientific Carry?

As you can see below, at the end of June 2022, XRF Scientific had AU$5.41m of debt, up from AU$4.61m a year ago. Click the image for more detail. However, its balance sheet shows it holds AU$6.65m in cash, so it actually has AU$1.24m net cash.

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 can boast AU$667.5k more liquid assets than total liabilities.

This state of affairs indicates that XRF Scientific's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the AU$102.7m company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, XRF Scientific boasts net cash, so it's fair to say it does not have a heavy debt load!

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. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Over the most recent three years, XRF Scientific recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

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 it impressed us with its EBIT growth of 39% over the last year. So is XRF Scientific's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 2 warning signs we've spotted with XRF Scientific .

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.

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

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.