Is Zaklady Urzadzen Komputerowych ELZAB (WSE:ELZ) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Zaklady Urzadzen Komputerowych ELZAB S.A. (WSE:ELZ) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Zaklady Urzadzen Komputerowych ELZAB

What Is Zaklady Urzadzen Komputerowych ELZAB's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zaklady Urzadzen Komputerowych ELZAB had zł53.2m of debt in September 2021, down from zł85.0m, one year before. However, because it has a cash reserve of zł1.31m, its net debt is less, at about zł51.9m.

How Strong Is Zaklady Urzadzen Komputerowych ELZAB's Balance Sheet?

According to the last reported balance sheet, Zaklady Urzadzen Komputerowych ELZAB had liabilities of zł71.1m due within 12 months, and liabilities of zł7.98m due beyond 12 months. Offsetting this, it had zł1.31m in cash and zł48.2m in receivables that were due within 12 months. So its liabilities total zł29.6m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Zaklady Urzadzen Komputerowych ELZAB has a market capitalization of zł62.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Zaklady Urzadzen Komputerowych ELZAB has net debt worth 2.1 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 6.6 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Pleasingly, Zaklady Urzadzen Komputerowych ELZAB is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 101% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Zaklady Urzadzen Komputerowych ELZAB will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. Over the last two years, Zaklady Urzadzen Komputerowych ELZAB actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Zaklady Urzadzen Komputerowych ELZAB's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its level of total liabilities. Taking all this data into account, it seems to us that Zaklady Urzadzen Komputerowych ELZAB takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. We've identified 3 warning signs with Zaklady Urzadzen Komputerowych ELZAB (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.