Here's Why Mikro MSC Berhad (KLSE:MIKROMB) Can Manage Its Debt Responsibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Mikro MSC Berhad (KLSE:MIKROMB) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Mikro MSC Berhad

How Much Debt Does Mikro MSC Berhad Carry?

The chart below, which you can click on for greater detail, shows that Mikro MSC Berhad had RM8.55m in debt in December 2021; about the same as the year before. However, its balance sheet shows it holds RM22.3m in cash, so it actually has RM13.7m net cash.

How Healthy Is Mikro MSC Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Mikro MSC Berhad had liabilities of RM10.1m due within 12 months and liabilities of RM9.77m due beyond that. Offsetting this, it had RM22.3m in cash and RM20.4m in receivables that were due within 12 months. So it actually has RM22.8m more liquid assets than total liabilities.

This surplus suggests that Mikro MSC Berhad is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Mikro MSC Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Mikro MSC Berhad's saving grace is its low debt levels, because its EBIT has tanked 23% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is Mikro MSC Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Mikro MSC Berhad 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 three years, Mikro MSC Berhad recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Mikro MSC Berhad has RM13.7m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 66% of that EBIT to free cash flow, bringing in RM2.3m. So we don't have any problem with Mikro MSC Berhad's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Mikro MSC Berhad (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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. 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.