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. 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. As with many other companies Grupo Empresarial San José, S.A. (BME:GSJ) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Grupo Empresarial San José

What Is Grupo Empresarial San José's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Grupo Empresarial San José had €188.8m of debt in December 2019, down from €429.5m, one year before. However, it does have €236.2m in cash offsetting this, leading to net cash of €47.4m.

How Healthy Is Grupo Empresarial San José's Balance Sheet?

We can see from the most recent balance sheet that Grupo Empresarial San José had liabilities of €634.3m falling due within a year, and liabilities of €202.9m due beyond that. Offsetting this, it had €236.2m in cash and €434.1m in receivables that were due within 12 months. So it has liabilities totalling €166.9m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Grupo Empresarial San José has a market capitalization of €279.6m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Grupo Empresarial San José also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Grupo Empresarial San José if management cannot prevent a repeat of the 70% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Grupo Empresarial San José 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. While Grupo Empresarial San José has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Grupo Empresarial San José 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 Grupo Empresarial San José does have more liabilities than liquid assets, it also has net cash of €47.4m. And it impressed us with free cash flow of €12m, being 199% of its EBIT. So we are not troubled with Grupo Empresarial San José's debt use. 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. To that end, you should learn about the 3 warning signs we've spotted with Grupo Empresarial San José (including 2 which is make us uncomfortable) .

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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