Here's Why Sanok Rubber Company Spólka Akcyjna (WSE:SNK) Can Manage Its Debt Responsibly

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 Sanok Rubber Company Spólka Akcyjna (WSE:SNK) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sanok Rubber Company Spólka Akcyjna

What Is Sanok Rubber Company Spólka Akcyjna's Net Debt?

As you can see below, Sanok Rubber Company Spólka Akcyjna had zł205.4m of debt at September 2022, down from zł237.8m a year prior. On the flip side, it has zł61.0m in cash leading to net debt of about zł144.4m.

A Look At Sanok Rubber Company Spólka Akcyjna's Liabilities

The latest balance sheet data shows that Sanok Rubber Company Spólka Akcyjna had liabilities of zł303.8m due within a year, and liabilities of zł190.9m falling due after that. On the other hand, it had cash of zł61.0m and zł247.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł185.9m.

While this might seem like a lot, it is not so bad since Sanok Rubber Company Spólka Akcyjna has a market capitalization of zł394.6m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Sanok Rubber Company Spólka Akcyjna's net debt is only 1.4 times its EBITDA. And its EBIT easily covers its interest expense, being 29.0 times the size. So we're pretty relaxed about its super-conservative use of debt. While Sanok Rubber Company Spólka Akcyjna doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sanok Rubber Company Spólka Akcyjna will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Sanok Rubber Company Spólka Akcyjna recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Sanok Rubber Company Spólka Akcyjna's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its level of total liabilities does undermine this impression a bit. All these things considered, it appears that Sanok Rubber Company Spólka Akcyjna can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the 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. To that end, you should learn about the 3 warning signs we've spotted with Sanok Rubber Company Spólka Akcyjna (including 1 which is a bit concerning) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.