David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Eurogerm SA (EPA:ALGEM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Eurogerm
What Is Eurogerm's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2018 Eurogerm had €12.1m of debt, an increase on €6.18m, over one year. But on the other hand it also has €22.8m in cash, leading to a €10.7m net cash position.
How Healthy Is Eurogerm's Balance Sheet?
According to the last reported balance sheet, Eurogerm had liabilities of €20.3m due within 12 months, and liabilities of €11.9m due beyond 12 months. Offsetting these obligations, it had cash of €22.8m as well as receivables valued at €23.3m due within 12 months. So it can boast €13.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Eurogerm could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Eurogerm boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Eurogerm grew its EBIT at 15% 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 you can't view debt in total isolation; since Eurogerm 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. Eurogerm 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 most recent three years, Eurogerm recorded free cash flow worth 51% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.