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Zicom Group (ASX:ZGL) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Zicom Group Limited (ASX:ZGL) does carry debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Zicom Group

How Much Debt Does Zicom Group Carry?

As you can see below, Zicom Group had S$19.5m of debt at June 2021, down from S$34.7m a year prior. But it also has S$20.3m in cash to offset that, meaning it has S$793.0k net cash.

debt-equity-history-analysis
debt-equity-history-analysis

A Look At Zicom Group's Liabilities

We can see from the most recent balance sheet that Zicom Group had liabilities of S$46.5m falling due within a year, and liabilities of S$13.2m due beyond that. Offsetting these obligations, it had cash of S$20.3m as well as receivables valued at S$21.5m due within 12 months. So its liabilities total S$17.9m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of S$25.9m, so it does suggest shareholders should keep an eye on Zicom Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Zicom Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Zicom Group's EBIT was down 79% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Zicom Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Zicom 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. Happily for any shareholders, Zicom Group 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 Zicom Group does have more liabilities than liquid assets, it also has net cash of S$793.0k. The cherry on top was that in converted 820% of that EBIT to free cash flow, bringing in S$26m. So although we see some areas for improvement, we're not too worried about Zicom Group's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Zicom Group , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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