Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Sapiens International Corporation N.V. (NASDAQ:SPNS) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Sapiens International

What Is Sapiens International's Net Debt?

As you can see below, Sapiens International had US$98.8m of debt at September 2021, down from US$118.5m a year prior. However, its balance sheet shows it holds US$184.7m in cash, so it actually has US$86.0m net cash.

How Healthy Is Sapiens International's Balance Sheet?

We can see from the most recent balance sheet that Sapiens International had liabilities of US$151.4m falling due within a year, and liabilities of US$157.6m due beyond that. Offsetting these obligations, it had cash of US$184.7m as well as receivables valued at US$90.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$33.6m.

Of course, Sapiens International has a market capitalization of US$1.66b, 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. While it does have liabilities worth noting, Sapiens International also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Sapiens International has been able to increase its EBIT by 24% 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 Sapiens International's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Sapiens International 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, Sapiens International actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Sapiens International has US$86.0m in net cash. And it impressed us with free cash flow of US$60m, being 112% of its EBIT. So we don't think Sapiens International's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Sapiens International, you may well want to click here to check an interactive graph of its earnings per share history.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.