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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that XRF Scientific Limited (ASX:XRF) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for XRF Scientific

What Is XRF Scientific's Net Debt?

As you can see below, XRF Scientific had AU$4.29m of debt at December 2023, down from AU$5.46m a year prior. However, it does have AU$8.32m in cash offsetting this, leading to net cash of AU$4.03m.

A Look At XRF Scientific's Liabilities

We can see from the most recent balance sheet that XRF Scientific had liabilities of AU$10.6m falling due within a year, and liabilities of AU$2.91m due beyond that. On the other hand, it had cash of AU$8.32m and AU$8.11m worth of receivables due within a year. So it can boast AU$2.91m 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 it's very unlikely that the AU$186.4m company is short on cash, but still worth keeping an eye on the 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.

Another good sign is that XRF Scientific has been able to increase its EBIT by 24% in twelve months, making it easier to pay down 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 47% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that XRF Scientific has net cash of AU$4.03m, as well as more liquid assets than liabilities. And we liked the look of last year's 24% 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, we've discovered 1 warning sign for XRF Scientific that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.