Powersoft (BIT:PWS) Seems To Use Debt Rather Sparingly

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.' 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 Powersoft S.p.A. (BIT:PWS) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Powersoft

How Much Debt Does Powersoft Carry?

The image below, which you can click on for greater detail, shows that at June 2023 Powersoft had debt of €2.19m, up from €220.0k in one year. However, its balance sheet shows it holds €19.4m in cash, so it actually has €17.2m net cash.

How Strong Is Powersoft's Balance Sheet?

The latest balance sheet data shows that Powersoft had liabilities of €17.4m due within a year, and liabilities of €3.96m falling due after that. Offsetting this, it had €19.4m in cash and €11.3m in receivables that were due within 12 months. So it actually has €9.38m more liquid assets than total liabilities.

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

Even more impressive was the fact that Powersoft grew its EBIT by 251% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Powersoft can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Powersoft 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. During the last three years, Powersoft generated free cash flow amounting to a very robust 85% 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 Powersoft has €17.2m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of €7.2m, being 85% of its EBIT. So is Powersoft'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 learn about the 2 warning signs we've spotted with Powersoft (including 1 which shouldn't be ignored) .

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.

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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.