KLON Spólka Akcyjna (WSE:KLN) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies KLON Spólka Akcyjna (WSE:KLN) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

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How Much Debt Does KLON Spólka Akcyjna Carry?

The image below, which you can click on for greater detail, shows that KLON Spólka Akcyjna had debt of zł9.00m at the end of June 2022, a reduction from zł10.8m over a year. On the flip side, it has zł307.1k in cash leading to net debt of about zł8.69m.

A Look At KLON Spólka Akcyjna's Liabilities

Zooming in on the latest balance sheet data, we can see that KLON Spólka Akcyjna had liabilities of zł4.07m due within 12 months and liabilities of zł7.37m due beyond that. On the other hand, it had cash of zł307.1k and zł4.36m worth of receivables due within a year. So its liabilities total zł6.78m more than the combination of its cash and short-term receivables.

Given KLON Spólka Akcyjna has a market capitalization of zł39.8m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

While KLON Spólka Akcyjna's debt to EBITDA ratio (3.0) suggests that it uses some debt, its interest cover is very weak, at 1.2, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Worse, KLON Spólka Akcyjna's EBIT was down 69% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since KLON 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, KLON Spólka Akcyjna created free cash flow amounting to 7.0% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

On the face of it, KLON Spólka Akcyjna's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to handle its total liabilities isn't such a worry. Overall, we think it's fair to say that KLON Spólka Akcyjna has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. To that end, you should learn about the 5 warning signs we've spotted with KLON Spólka Akcyjna (including 4 which are a bit concerning) .

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.