These 4 Measures Indicate That Rainbow Tours (WSE:RBW) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Rainbow Tours S.A. (WSE:RBW) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Rainbow Tours

What Is Rainbow Tours's Debt?

As you can see below, Rainbow Tours had zł45.1m of debt at September 2023, down from zł111.4m a year prior. But it also has zł386.3m in cash to offset that, meaning it has zł341.2m net cash.

A Look At Rainbow Tours' Liabilities

According to the last reported balance sheet, Rainbow Tours had liabilities of zł697.9m due within 12 months, and liabilities of zł92.9m due beyond 12 months. On the other hand, it had cash of zł386.3m and zł75.6m worth of receivables due within a year. So its liabilities total zł328.9m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Rainbow Tours has a market capitalization of zł1.01b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Rainbow Tours boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Rainbow Tours grew its EBIT by 599% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Rainbow Tours'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, a company can only pay off debt with cold hard cash, not accounting profits. Rainbow Tours 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. Happily for any shareholders, Rainbow Tours actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While Rainbow Tours does have more liabilities than liquid assets, it also has net cash of zł341.2m. The cherry on top was that in converted 197% of that EBIT to free cash flow, bringing in zł245m. So is Rainbow Tours's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Rainbow Tours is showing 1 warning sign in our investment analysis , you should know about...

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.