Elspec Engineering (TLV:ELSPC) Has A Pretty Healthy Balance Sheet

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 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. As with many other companies Elspec Engineering Ltd (TLV:ELSPC) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Elspec Engineering

How Much Debt Does Elspec Engineering Carry?

As you can see below, Elspec Engineering had ₪6.21m of debt at June 2021, down from ₪8.41m a year prior. However, it does have ₪31.9m in cash offsetting this, leading to net cash of ₪25.7m.

How Strong Is Elspec Engineering's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Elspec Engineering had liabilities of ₪15.9m due within 12 months and liabilities of ₪6.26m due beyond that. Offsetting these obligations, it had cash of ₪31.9m as well as receivables valued at ₪12.0m due within 12 months. So it actually has ₪21.7m more liquid assets than total liabilities.

It's good to see that Elspec Engineering has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Elspec Engineering has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Elspec Engineering's load is not too heavy, because its EBIT was down 78% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is Elspec Engineering's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Elspec Engineering 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, Elspec Engineering generated free cash flow amounting to a very robust 98% 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 Elspec Engineering has ₪25.7m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₪6.3m, being 98% of its EBIT. So is Elspec Engineering's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Elspec Engineering .

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.

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.

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