Here's Why MFO Spólka Akcyjna (WSE:MFO) Can Manage Its Debt Responsibly

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 note that MFO Spólka Akcyjna (WSE:MFO) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for MFO Spólka Akcyjna

What Is MFO Spólka Akcyjna's Net Debt?

You can click the graphic below for the historical numbers, but it shows that MFO Spólka Akcyjna had zł47.5m of debt in September 2020, down from zł57.3m, one year before. But on the other hand it also has zł55.8m in cash, leading to a zł8.24m net cash position.

How Healthy Is MFO Spólka Akcyjna's Balance Sheet?

According to the last reported balance sheet, MFO Spólka Akcyjna had liabilities of zł99.6m due within 12 months, and liabilities of zł37.5m due beyond 12 months. On the other hand, it had cash of zł55.8m and zł44.7m worth of receivables due within a year. So its liabilities total zł36.6m more than the combination of its cash and short-term receivables.

Given MFO Spólka Akcyjna has a market capitalization of zł202.2m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, MFO Spólka Akcyjna also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for MFO Spólka Akcyjna if management cannot prevent a repeat of the 23% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 MFO 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. MFO Spólka Akcyjna 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. Looking at the most recent three years, MFO Spólka Akcyjna recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While MFO Spólka Akcyjna does have more liabilities than liquid assets, it also has net cash of zł8.24m. So we don't have any problem with MFO Spólka Akcyjna's use of debt. 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. For example - MFO Spólka Akcyjna has 2 warning signs we think you should be aware of.

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. 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.
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