These 4 Measures Indicate That EKF Diagnostics Holdings (LON:EKF) Is Using Debt Reasonably Well

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that EKF Diagnostics Holdings plc (LON:EKF) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for EKF Diagnostics Holdings

How Much Debt Does EKF Diagnostics Holdings Carry?

The image below, which you can click on for greater detail, shows that at December 2023 EKF Diagnostics Holdings had debt of UK£2.99m, up from UK£137.0k in one year. But on the other hand it also has UK£7.73m in cash, leading to a UK£4.74m net cash position.

How Healthy Is EKF Diagnostics Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that EKF Diagnostics Holdings had liabilities of UK£9.50m due within 12 months and liabilities of UK£3.14m due beyond that. Offsetting these obligations, it had cash of UK£7.73m as well as receivables valued at UK£9.06m due within 12 months. So it actually has UK£4.16m more liquid assets than total liabilities.

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

In fact EKF Diagnostics Holdings's saving grace is its low debt levels, because its EBIT has tanked 49% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 EKF Diagnostics Holdings'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 EKF Diagnostics Holdings 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. In the last three years, EKF Diagnostics Holdings's free cash flow amounted to 22% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that EKF Diagnostics Holdings has net cash of UK£4.74m, as well as more liquid assets than liabilities. So we are not troubled with EKF Diagnostics Holdings's debt use. 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. For example, we've discovered 2 warning signs for EKF Diagnostics Holdings (1 is concerning!) that you should be aware of before investing here.

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.