Here's Why Smart Organic AD (BUL:SO) Can Manage Its Debt Responsibly

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Smart Organic AD (BUL:SO) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Smart Organic AD's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2024 Smart Organic AD had debt of лв17.8m, up from лв10.4m in one year. However, it also had лв10.2m in cash, and so its net debt is лв7.61m.

How Strong Is Smart Organic AD's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Smart Organic AD had liabilities of лв15.6m due within 12 months and liabilities of лв14.9m due beyond that. On the other hand, it had cash of лв10.2m and лв22.9m worth of receivables due within a year. So it can boast лв2.66m more liquid assets than total liabilities.

Having regard to Smart Organic AD's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the лв344.8m company is struggling for cash, we still think it's worth monitoring its balance sheet.

View our latest analysis for Smart Organic AD

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Smart Organic AD's net debt is only 0.23 times its EBITDA. And its EBIT easily covers its interest expense, being 154 times the size. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Smart Organic AD grew its EBIT by 129% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Smart Organic AD will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Smart Organic AD saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

The good news is that Smart Organic AD's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Taking all this data into account, it seems to us that Smart Organic AD takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Smart Organic AD , and understanding them should be part of your investment process.

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.

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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.