Does Xref (ASX:XF1) Have A Healthy Balance Sheet?

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 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. We can see that Xref Limited (ASX:XF1) does use debt in its business. 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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Xref

What Is Xref's Net Debt?

As you can see below, Xref had AU$4.63m of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. But it also has AU$11.7m in cash to offset that, meaning it has AU$7.04m net cash.

A Look At Xref's Liabilities

According to the last reported balance sheet, Xref had liabilities of AU$14.1m due within 12 months, and liabilities of AU$4.63m due beyond 12 months. Offsetting these obligations, it had cash of AU$11.7m as well as receivables valued at AU$3.10m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$3.92m.

Given Xref has a market capitalization of AU$63.8m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Xref boasts net cash, so it's fair to say it does not have a heavy debt load!

We also note that Xref improved its EBIT from a last year's loss to a positive AU$1.2m. There's no doubt that we learn most about debt from the balance sheet. But it is Xref's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Xref 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 last year, Xref actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Xref has AU$7.04m in net cash. The cherry on top was that in converted 270% of that EBIT to free cash flow, bringing in AU$3.2m. So we are not troubled with Xref's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Xref has 2 warning signs we think you should be aware of.

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.