Farmaè (BIT:FAR) Has A Pretty Healthy Balance Sheet

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.' 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 Farmaè S.p.A. (BIT:FAR) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Farmaè

What Is Farmaè's Net Debt?

As you can see below, at the end of December 2020, Farmaè had €10.7m of debt, up from €4.25m a year ago. Click the image for more detail. But it also has €13.9m in cash to offset that, meaning it has €3.22m net cash.

How Strong Is Farmaè's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Farmaè had liabilities of €22.7m due within 12 months and liabilities of €8.59m due beyond that. On the other hand, it had cash of €13.9m and €3.69m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €13.7m.

Given Farmaè has a market capitalization of €155.4m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Farmaè boasts net cash, so it's fair to say it does not have a heavy debt load!

Notably, Farmaè made a loss at the EBIT level, last year, but improved that to positive EBIT of €1.1m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Farmaè'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Farmaè 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 year, Farmaè 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

We could understand if investors are concerned about Farmaè's liabilities, but we can be reassured by the fact it has has net cash of €3.22m. And it impressed us with free cash flow of €1.7m, being 161% of its EBIT. So we are not troubled with Farmaè's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Farmaè you should know about.

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.

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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.
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