These 4 Measures Indicate That Watches of Switzerland Group (LON:WOSG) Is Using Debt Safely

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.' 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 Watches of Switzerland Group plc (LON:WOSG) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Watches of Switzerland Group

What Is Watches of Switzerland Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Watches of Switzerland Group had UK£118.3m of debt in October 2021, down from UK£139.7m, one year before. However, its balance sheet shows it holds UK£150.0m in cash, so it actually has UK£31.8m net cash.

How Strong Is Watches of Switzerland Group's Balance Sheet?

We can see from the most recent balance sheet that Watches of Switzerland Group had liabilities of UK£233.3m falling due within a year, and liabilities of UK£385.5m due beyond that. Offsetting these obligations, it had cash of UK£150.0m as well as receivables valued at UK£11.2m due within 12 months. So it has liabilities totalling UK£457.4m more than its cash and near-term receivables, combined.

Since publicly traded Watches of Switzerland Group shares are worth a total of UK£2.97b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Watches of Switzerland Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Watches of Switzerland Group has boosted its EBIT by 73%, thus reducing the spectre of future debt repayments. 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 Watches of Switzerland Group'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 Watches of Switzerland Group 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 last three years, Watches of Switzerland Group actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although Watches of Switzerland 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£31.8m. And it impressed us with free cash flow of UK£119m, being 126% of its EBIT. So is Watches of Switzerland Group'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. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Watches of Switzerland Group is showing 1 warning sign in our investment analysis , you should know about...

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.