Is XP Factory (LON:XPF) Using Too Much Debt?

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. We can see that XP Factory Plc (LON:XPF) does use debt in its business. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 XP Factory

How Much Debt Does XP Factory Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 XP Factory had UK£1.65m of debt, an increase on UK£289.0k, over one year. But on the other hand it also has UK£11.6m in cash, leading to a UK£9.93m net cash position.

A Look At XP Factory's Liabilities

Zooming in on the latest balance sheet data, we can see that XP Factory had liabilities of UK£7.31m due within 12 months and liabilities of UK£19.8m due beyond that. On the other hand, it had cash of UK£11.6m and UK£970.0k worth of receivables due within a year. So it has liabilities totalling UK£14.6m more than its cash and near-term receivables, combined.

XP Factory has a market capitalization of UK£25.6m, so it could very likely raise cash to ameliorate 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, XP Factory also has more cash than debt, so we're pretty confident it can manage its debt safely. 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 XP Factory'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.

In the last year XP Factory wasn't profitable at an EBIT level, but managed to grow its revenue by 163%, to UK£7.0m. So there's no doubt that shareholders are cheering for growth

So How Risky Is XP Factory?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that XP Factory had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of UK£2.0m and booked a UK£877k accounting loss. Given it only has net cash of UK£9.93m, the company may need to raise more capital if it doesn't reach break-even soon. Importantly, XP Factory's revenue growth is hot to trot. While unprofitable companies can be risky, they can also grow hard and fast in those pre-profit years. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for XP Factory (of which 1 is significant!) you should know about.

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.