Is CML Microsystems (LON:CML) 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that CML Microsystems plc (LON:CML) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for CML Microsystems

How Much Debt Does CML Microsystems Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 CML Microsystems had UK£1.66m of debt, an increase on none, over one year. But on the other hand it also has UK£9.01m in cash, leading to a UK£7.35m net cash position.

A Look At CML Microsystems's Liabilities

The latest balance sheet data shows that CML Microsystems had liabilities of UK£6.50m due within a year, and liabilities of UK£10.2m falling due after that. Offsetting these obligations, it had cash of UK£9.01m as well as receivables valued at UK£5.83m due within 12 months. So its liabilities total UK£1.88m more than the combination of its cash and short-term receivables.

Given CML Microsystems has a market capitalization of UK£60.5m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, CML Microsystems boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that CML Microsystems has boosted its EBIT by 59%, thus reducing the spectre of future debt repayments. 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 CML Microsystems 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, a company can only pay off debt with cold hard cash, not accounting profits. CML Microsystems 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. Over the last three years, CML Microsystems reported free cash flow worth 17% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

We could understand if investors are concerned about CML Microsystems's liabilities, but we can be reassured by the fact it has has net cash of UK£7.35m. And it impressed us with its EBIT growth of 59% over the last year. So we don't think CML Microsystems's use of debt is risky. 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 instance, we've identified 4 warning signs for CML Microsystems (1 shouldn't be ignored) you should be aware of.

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.

When trading CML Microsystems or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.