Saras (BIT:SRS) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Saras S.p.A. (BIT:SRS) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for Saras

How Much Debt Does Saras Carry?

As you can see below, Saras had €741.3m of debt at June 2022, down from €1.01b a year prior. However, its balance sheet shows it holds €820.0m in cash, so it actually has €78.7m net cash.

A Look At Saras' Liabilities

The latest balance sheet data shows that Saras had liabilities of €3.01b due within a year, and liabilities of €875.5m falling due after that. Offsetting these obligations, it had cash of €820.0m as well as receivables valued at €846.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €2.22b.

The deficiency here weighs heavily on the €1.12b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Saras would probably need a major re-capitalization if its creditors were to demand repayment. Saras boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Although Saras made a loss at the EBIT level, last year, it was also good to see that it generated €662m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Saras's ability to maintain a healthy balance sheet going forward. 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. Saras 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 most recent year, Saras recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Saras's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €78.7m. So although we see some areas for improvement, we're not too worried about Saras's balance sheet. 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. Case in point: We've spotted 2 warning signs for Saras you should be aware of.

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.

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

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.