Xref (ASX:XF1) Has A Rock Solid Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Xref Limited (ASX:XF1) makes use of debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Xref

What Is Xref's Debt?

As you can see below, Xref had AU$4.56m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. But it also has AU$10.4m in cash to offset that, meaning it has AU$5.89m net cash.

How Healthy Is Xref's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Xref had liabilities of AU$12.6m due within 12 months and liabilities of AU$4.32m due beyond that. On the other hand, it had cash of AU$10.4m and AU$2.55m worth of receivables due within a year. So it has liabilities totalling AU$3.96m more than its cash and near-term receivables, combined.

Of course, Xref has a market capitalization of AU$96.4m, so these liabilities are probably manageable. 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!

Although Xref made a loss at the EBIT level, last year, it was also good to see that it generated AU$2.0m in EBIT over the last twelve months. 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 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Xref 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. 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

We could understand if investors are concerned about Xref's liabilities, but we can be reassured by the fact it has has net cash of AU$5.89m. The cherry on top was that in converted 173% of that EBIT to free cash flow, bringing in AU$3.5m. So is Xref'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. Be aware that Xref is showing 2 warning signs in our investment analysis , you should know about...

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.