Is Macfarlane Group (LON:MACF) A Risky Investment?

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.' 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. As with many other companies Macfarlane Group PLC (LON:MACF) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Macfarlane Group

How Much Debt Does Macfarlane Group Carry?

You can click the graphic below for the historical numbers, but it shows that Macfarlane Group had UK£7.16m of debt in December 2023, down from UK£9.14m, one year before. But on the other hand it also has UK£7.69m in cash, leading to a UK£527.0k net cash position.

A Look At Macfarlane Group's Liabilities

The latest balance sheet data shows that Macfarlane Group had liabilities of UK£66.5m due within a year, and liabilities of UK£40.2m falling due after that. On the other hand, it had cash of UK£7.69m and UK£51.6m worth of receivables due within a year. So it has liabilities totalling UK£47.4m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Macfarlane Group is worth UK£198.2m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Macfarlane Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Macfarlane Group has increased its EBIT by 4.2% over twelve months, which should ease any concerns about debt repayment. 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 Macfarlane Group 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Macfarlane Group 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. Happily for any shareholders, Macfarlane Group actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although Macfarlane Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£527.0k. The cherry on top was that in converted 105% of that EBIT to free cash flow, bringing in UK£31m. So we don't think Macfarlane Group's use of debt is risky. 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. We've identified 2 warning signs with Macfarlane Group , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.