Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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. Importantly, Science Group plc (LON:SAG) does carry debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. 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.

See our latest analysis for Science Group

What Is Science Group’s Net Debt?

You can click the graphic below for the historical numbers, but it shows that Science Group had UK£15.3m of debt in December 2021, down from UK£17.1m, one year before. But on the other hand it also has UK£34.3m in cash, leading to a UK£19.0m net cash position.

How Healthy Is Science Group’s Balance Sheet?

The latest balance sheet data shows that Science Group had liabilities of UK£33.8m due within a year, and liabilities of UK£15.8m falling due after that. On the other hand, it had cash of UK£34.3m and UK£12.2m worth of receivables due within a year. So it has liabilities totalling UK£3.10m more than its cash and near-term receivables, combined.

This state of affairs indicates that Science Group’s balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it’s very unlikely that the UK£196.6m company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Science Group boasts net cash, so it’s fair to say it does not have a heavy debt load!

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In addition to that, we’re happy to report that Science Group has boosted its EBIT by 77%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Science Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Science Group 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 two years, Science Group actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to look at a company’s total liabilities, it is very reassuring that Science Group has UK£19.0m in net cash. And it impressed us with free cash flow of UK£9.2m, being 135% of its EBIT. So we don’t think Science Group’s use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Science Group is showing 1 warning sign in our investment analysis , you should know about…

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.