We Think Magic Software Enterprises (NASDAQ:MGIC) Can Manage Its Debt With Ease

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Magic Software Enterprises Ltd. (NASDAQ:MGIC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Magic Software Enterprises

How Much Debt Does Magic Software Enterprises Carry?

The image below, which you can click on for greater detail, shows that at March 2021 Magic Software Enterprises had debt of US$23.0m, up from US$19.9m in one year. But on the other hand it also has US$99.0m in cash, leading to a US$76.0m net cash position.

How Strong Is Magic Software Enterprises' Balance Sheet?

We can see from the most recent balance sheet that Magic Software Enterprises had liabilities of US$103.6m falling due within a year, and liabilities of US$63.8m due beyond that. Offsetting this, it had US$99.0m in cash and US$125.3m in receivables that were due within 12 months. So it can boast US$56.9m 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!

In addition to that, we're happy to report that Magic Software Enterprises has boosted its EBIT by 33%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Magic Software Enterprises can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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 it is always sensible to investigate a company's debt, in this case Magic Software Enterprises has US$76.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$49m, being 103% of its EBIT. 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. To that end, you should be aware of the 2 warning signs we've spotted with Magic Software Enterprises .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.
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