These 4 Measures Indicate That Dom Development (WSE:DOM) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 can see that Dom Development S.A. (WSE:DOM) does use debt in its business. 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. If things get really bad, the lenders can take control of the business. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Dom Development

What Is Dom Development's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Dom Development had zł485.9m of debt, an increase on zł383.0m, over one year. However, its balance sheet shows it holds zł637.5m in cash, so it actually has zł151.6m net cash.

How Strong Is Dom Development's Balance Sheet?

The latest balance sheet data shows that Dom Development had liabilities of zł1.92b due within a year, and liabilities of zł584.4m falling due after that. Offsetting these obligations, it had cash of zł637.5m as well as receivables valued at zł57.4m due within 12 months. So it has liabilities totalling zł1.81b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of zł2.77b, so it does suggest shareholders should keep an eye on Dom Development's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Dom Development also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Dom Development grew its EBIT by 55% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Dom Development can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Dom Development 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 last three years, Dom Development recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While Dom Development does have more liabilities than liquid assets, it also has net cash of zł151.6m. And it impressed us with free cash flow of zł535m, being 89% of its EBIT. So we don't think Dom Development's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Dom Development (1 makes us a bit uncomfortable) 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.