These 4 Measures Indicate That SFC Energy (ETR:F3C) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that SFC Energy AG (ETR:F3C) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for SFC Energy

What Is SFC Energy's Net Debt?

As you can see below, SFC Energy had €3.91m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds €56.8m in cash, so it actually has €52.9m net cash.

A Look At SFC Energy's Liabilities

We can see from the most recent balance sheet that SFC Energy had liabilities of €31.1m falling due within a year, and liabilities of €16.2m due beyond that. Offsetting these obligations, it had cash of €56.8m as well as receivables valued at €31.5m due within 12 months. So it can boast €41.0m more liquid assets than total liabilities.

This short term liquidity is a sign that SFC Energy could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, SFC Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that SFC Energy grew its EBIT by 295% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine SFC Energy's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While SFC Energy 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, SFC Energy saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case SFC Energy has €52.9m in net cash and a decent-looking balance sheet. And we liked the look of last year's 295% year-on-year EBIT growth. So we don't have any problem with SFC Energy's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with SFC Energy .

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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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.