Does Gamma Communications (LON:GAMA) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Gamma Communications plc (LON:GAMA) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Gamma Communications

How Much Debt Does Gamma Communications Carry?

The image below, which you can click on for greater detail, shows that Gamma Communications had debt of UK£1.80m at the end of June 2023, a reduction from UK£3.00m over a year. But on the other hand it also has UK£123.5m in cash, leading to a UK£121.7m net cash position.

A Look At Gamma Communications' Liabilities

The latest balance sheet data shows that Gamma Communications had liabilities of UK£72.1m due within a year, and liabilities of UK£30.1m falling due after that. On the other hand, it had cash of UK£123.5m and UK£109.4m worth of receivables due within a year. So it actually has UK£130.7m more liquid assets than total liabilities.

This short term liquidity is a sign that Gamma Communications could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Gamma Communications boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Gamma Communications saw its EBIT decline by 8.2% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Gamma Communications 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Gamma Communications 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. During the last three years, Gamma Communications generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Gamma Communications has UK£121.7m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of UK£71m, being 84% of its EBIT. So is Gamma Communications's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Gamma Communications's earnings per share history for free.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.