Is ScanSource (NASDAQ:SCSC) A Risky Investment?

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.' 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, ScanSource, Inc. (NASDAQ:SCSC) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for ScanSource

What Is ScanSource's Debt?

The image below, which you can click on for greater detail, shows that ScanSource had debt of US$143.6m at the end of September 2024, a reduction from US$248.1m over a year. However, it does have US$145.0m in cash offsetting this, leading to net cash of US$1.40m.

How Strong Is ScanSource's Balance Sheet?

The latest balance sheet data shows that ScanSource had liabilities of US$666.0m due within a year, and liabilities of US$199.6m falling due after that. On the other hand, it had cash of US$145.0m and US$567.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$153.4m.

Of course, ScanSource has a market capitalization of US$1.21b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, ScanSource boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact ScanSource's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if ScanSource can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. ScanSource 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. Over the last three years, ScanSource recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

Although ScanSource's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$1.40m. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in US$314m. So we are not troubled with ScanSource's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that ScanSource insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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. 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.