Zaklady Urzadzen Kotlowych Staporków Spólka Akcyjna (WSE:ZUK) Has A Somewhat Strained 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. We can see that Zaklady Urzadzen Kotlowych "Staporków" Spólka Akcyjna (WSE:ZUK) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Zaklady Urzadzen Kotlowych Staporków Spólka Akcyjna

What Is Zaklady Urzadzen Kotlowych Staporków Spólka Akcyjna's Debt?

The chart below, which you can click on for greater detail, shows that Zaklady Urzadzen Kotlowych Staporków Spólka Akcyjna had zł13.3m in debt in March 2022; about the same as the year before. However, it does have zł643.0k in cash offsetting this, leading to net debt of about zł12.6m.

A Look At Zaklady Urzadzen Kotlowych Staporków Spólka Akcyjna's Liabilities

We can see from the most recent balance sheet that Zaklady Urzadzen Kotlowych Staporków Spólka Akcyjna had liabilities of zł26.9m falling due within a year, and liabilities of zł2.13m due beyond that. On the other hand, it had cash of zł643.0k and zł12.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł15.5m.

This deficit is considerable relative to its market capitalization of zł19.8m, so it does suggest shareholders should keep an eye on Zaklady Urzadzen Kotlowych Staporków Spólka Akcyjna's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

We'd say that Zaklady Urzadzen Kotlowych Staporków Spólka Akcyjna's moderate net debt to EBITDA ratio ( being 2.4), indicates prudence when it comes to debt. And its commanding EBIT of 56.7 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, Zaklady Urzadzen Kotlowych Staporków Spólka Akcyjna grew its EBIT by 82% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Zaklady Urzadzen Kotlowych Staporków 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, Zaklady Urzadzen Kotlowych Staporków Spólka Akcyjna recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

We feel some trepidation about Zaklady Urzadzen Kotlowych Staporków Spólka Akcyjna's difficulty conversion of EBIT to free cash flow, but we've got positives to focus on, too. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. We think that Zaklady Urzadzen Kotlowych Staporków Spólka Akcyjna's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Zaklady Urzadzen Kotlowych Staporków Spólka Akcyjna that you should be aware of.

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.