SimCorp (CPH:SIM) Has A Pretty Healthy 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies SimCorp A/S (CPH:SIM) makes use of 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for SimCorp

What Is SimCorp's Debt?

As you can see below, at the end of March 2022, SimCorp had €20.2m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has €49.8m in cash, leading to a €29.6m net cash position.

How Strong Is SimCorp's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that SimCorp had liabilities of €189.6m due within 12 months and liabilities of €75.4m due beyond that. On the other hand, it had cash of €49.8m and €348.8m worth of receivables due within a year. So it can boast €133.5m more liquid assets than total liabilities.

This surplus suggests that SimCorp has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that SimCorp has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that SimCorp saw its EBIT decline by 5.2% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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 SimCorp'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While SimCorp 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 most recent three years, SimCorp recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case SimCorp has €29.6m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in €70m. So we don't think SimCorp's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for SimCorp that you should be aware of.

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.