Does Laboratorios Farmaceuticos Rovi (BME:ROVI) Have A 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.' 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. As with many other companies Laboratorios Farmaceuticos Rovi, S.A. (BME:ROVI) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Laboratorios Farmaceuticos Rovi

What Is Laboratorios Farmaceuticos Rovi's Debt?

The chart below, which you can click on for greater detail, shows that Laboratorios Farmaceuticos Rovi had €55.0m in debt in September 2022; about the same as the year before. But it also has €97.6m in cash to offset that, meaning it has €42.6m net cash.

How Strong Is Laboratorios Farmaceuticos Rovi's Balance Sheet?

The latest balance sheet data shows that Laboratorios Farmaceuticos Rovi had liabilities of €258.3m due within a year, and liabilities of €70.8m falling due after that. Offsetting this, it had €97.6m in cash and €150.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €80.9m.

Given Laboratorios Farmaceuticos Rovi has a market capitalization of €2.30b, 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, Laboratorios Farmaceuticos Rovi also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Laboratorios Farmaceuticos Rovi grew its EBIT by 48% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Laboratorios Farmaceuticos Rovi can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Laboratorios Farmaceuticos Rovi may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Laboratorios Farmaceuticos Rovi produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Laboratorios Farmaceuticos Rovi's liabilities, but we can be reassured by the fact it has has net cash of €42.6m. And it impressed us with its EBIT growth of 48% over the last year. So is Laboratorios Farmaceuticos Rovi's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Laboratorios Farmaceuticos Rovi has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.