These 4 Measures Indicate That Darco Water Technologies (SGX:BLR) Is Using Debt Reasonably Well

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.' 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 Darco Water Technologies Limited (SGX:BLR) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Darco Water Technologies

What Is Darco Water Technologies's Debt?

As you can see below, at the end of June 2023, Darco Water Technologies had S$5.71m of debt, up from S$3.77m a year ago. Click the image for more detail. However, it does have S$13.2m in cash offsetting this, leading to net cash of S$7.47m.

A Look At Darco Water Technologies' Liabilities

We can see from the most recent balance sheet that Darco Water Technologies had liabilities of S$40.4m falling due within a year, and liabilities of S$7.05m due beyond that. Offsetting this, it had S$13.2m in cash and S$45.7m in receivables that were due within 12 months. So it actually has S$11.4m more liquid assets than total liabilities.

This luscious liquidity implies that Darco Water Technologies' balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Darco Water Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.

Notably, Darco Water Technologies made a loss at the EBIT level, last year, but improved that to positive EBIT of S$1.2m in the last twelve months. 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 Darco Water Technologies 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. While Darco Water Technologies has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, Darco Water Technologies saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, the bottom line is that Darco Water Technologies has net cash of S$7.47m and plenty of liquid assets. So we don't have any problem with Darco Water Technologies's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Darco Water Technologies that 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.