Does Magic Software Enterprises (NASDAQ:MGIC) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Magic Software Enterprises Ltd. (NASDAQ:MGIC) does use debt in its business. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Magic Software Enterprises

What Is Magic Software Enterprises's Debt?

As you can see below, Magic Software Enterprises had US$28.8m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$83.4m in cash offsetting this, leading to net cash of US$54.5m.

How Healthy Is Magic Software Enterprises' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Magic Software Enterprises had liabilities of US$77.5m due within 12 months and liabilities of US$67.5m due beyond that. On the other hand, it had cash of US$83.4m and US$111.3m worth of receivables due within a year. So it can boast US$49.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Magic Software Enterprises could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Magic Software Enterprises boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Magic Software Enterprises grew its EBIT at 16% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Magic Software Enterprises's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Magic Software Enterprises 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. Happily for any shareholders, Magic Software Enterprises actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Magic Software Enterprises has net cash of US$54.5m, as well as more liquid assets than liabilities. The cherry on top was that in converted 103% of that EBIT to free cash flow, bringing in US$48m. So we don't think Magic Software Enterprises's use of debt is risky. 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. Be aware that Magic Software Enterprises is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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