PSI Software (ETR:PSAN) Has A Pretty Healthy Balance Sheet

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 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. We can see that PSI Software AG (ETR:PSAN) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for PSI Software

What Is PSI Software's Debt?

As you can see below, at the end of March 2021, PSI Software had €4.55m of debt, up from €429.0k a year ago. Click the image for more detail. However, its balance sheet shows it holds €54.1m in cash, so it actually has €49.6m net cash.

How Healthy Is PSI Software's Balance Sheet?

According to the last reported balance sheet, PSI Software had liabilities of €93.4m due within 12 months, and liabilities of €90.1m due beyond 12 months. Offsetting these obligations, it had cash of €54.1m as well as receivables valued at €87.8m due within 12 months. So it has liabilities totalling €41.6m more than its cash and near-term receivables, combined.

Since publicly traded PSI Software shares are worth a total of €491.3m, it seems unlikely that this level of liabilities would be a major 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, PSI Software also has more cash than debt, so we're pretty confident it can manage its debt safely.

While PSI Software doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if PSI Software can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While PSI Software 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, PSI Software recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that PSI Software has €49.6m in net cash. The cherry on top was that in converted 96% of that EBIT to free cash flow, bringing in €22m. So we don't think PSI Software's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of PSI Software's earnings per share history for free.

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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