Is Xref (ASX:XF1) A Risky Investment?

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. As with many other companies Xref Limited (ASX:XF1) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Xref

What Is Xref's Net Debt?

As you can see below, at the end of December 2022, Xref had AU$5.05m of debt, up from AU$4.56m a year ago. Click the image for more detail. However, its balance sheet shows it holds AU$11.4m in cash, so it actually has AU$6.40m net cash.

A Look At Xref's Liabilities

We can see from the most recent balance sheet that Xref had liabilities of AU$14.8m falling due within a year, and liabilities of AU$4.66m due beyond that. On the other hand, it had cash of AU$11.4m and AU$3.03m worth of receivables due within a year. So its liabilities total AU$4.97m more than the combination of its cash and short-term receivables.

Of course, Xref has a market capitalization of AU$39.1m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Xref boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Xref's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Xref wasn't profitable at an EBIT level, but managed to grow its revenue by 19%, to AU$19m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

So How Risky Is Xref?

While Xref lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow AU$1.7m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Xref .

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.

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.