Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ So it might be obvious that you need to consider debt when you think about how risky any given stock is because too much debt can sink a company. We note that PSI Software AG (ETR:PSAN) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. However, a more usual situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 examine debt levels, we first consider both cash and debt levels, together.
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What Is PSI Software’s Net Debt?
The image below, which you can click on for greater detail, shows that in June 2021 PSI Software had a debt of €4.24m, up from €739.0k in one year. However, its balance sheet shows it holds €45.4m in cash, so it actually has €41.1m net cash.
A Look At PSI Software’s Liabilities
According to the last reported balance sheet, PSI Software had liabilities of €84.9m due within 12 months, and liabilities of €89.4m due beyond 12 months. Offsetting this, it had €45.4m in cash and €90.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €38.4m.
Given PSI Software has a market capitalization of €609.7m, it’s hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, PSI Software also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Another good sign is that PSI Software has been able to increase its EBIT by 21% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PSI Software’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 company can only pay off debt with cold hard cash, not accounting profits. PSI Software 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, PSI Software recorded free cash flow worth a fulsome 92% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
We could understand if investors are concerned about PSI Software’s liabilities, but we can be reassured by the fact it has net cash of €41.1m. And it impressed us with a free cash flow of €11m, being 92% of its EBIT. So we don’t think PSI Software’s use of debt is risky. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example – PSI Software has 1 warning sign we think you should be aware of.
When all is said and done, sometimes it’s 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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