Compañía Chilena de Fósforos (SNSE:FOSFOROS) Has A Pretty Healthy Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Compañía Chilena de Fósforos S.A. (SNSE:FOSFOROS) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Compañía Chilena de Fósforos

How Much Debt Does Compañía Chilena de Fósforos Carry?

As you can see below, at the end of December 2020, Compañía Chilena de Fósforos had CL$6.67b of debt, up from CL$1.88b a year ago. Click the image for more detail. However, its balance sheet shows it holds CL$9.63b in cash, so it actually has CL$2.96b net cash.

How Healthy Is Compañía Chilena de Fósforos' Balance Sheet?

According to the last reported balance sheet, Compañía Chilena de Fósforos had liabilities of CL$8.68b due within 12 months, and liabilities of CL$8.75b due beyond 12 months. On the other hand, it had cash of CL$9.63b and CL$5.81b worth of receivables due within a year. So it has liabilities totalling CL$1.99b more than its cash and near-term receivables, combined.

Given Compañía Chilena de Fósforos has a market capitalization of CL$61.5b, 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. While it does have liabilities worth noting, Compañía Chilena de Fósforos also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Compañía Chilena de Fósforos has increased its EBIT by 7.2% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Compañía Chilena de Fósforos will need earnings to service that debt. 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 Compañía Chilena de Fósforos 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 three years, Compañía Chilena de Fósforos 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.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Compañía Chilena de Fósforos has CL$2.96b in net cash. On top of that, it increased its EBIT by 7.2% in the last twelve months. So we are not troubled with Compañía Chilena de Fósforos's debt use. 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. Case in point: We've spotted 3 warning signs for Compañía Chilena de Fósforos you should be aware of, and 1 of them is potentially serious.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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