Warren Buffett famously said, '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. As with many other companies Schaffer Corporation Limited (ASX:SFC) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Schaffer

How Much Debt Does Schaffer Carry?

As you can see below, Schaffer had AU$29.7m of debt at June 2019, down from AU$33.3m a year prior. But on the other hand it also has AU$36.8m in cash, leading to a AU$7.10m net cash position.

How Healthy Is Schaffer's Balance Sheet?

According to the last reported balance sheet, Schaffer had liabilities of AU$60.2m due within 12 months, and liabilities of AU$32.0m due beyond 12 months. Offsetting this, it had AU$36.8m in cash and AU$32.9m in receivables that were due within 12 months. So its liabilities total AU$22.5m more than the combination of its cash and short-term receivables.

Given Schaffer has a market capitalization of AU$192.5m, 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. Despite its noteworthy liabilities, Schaffer boasts net cash, so it's fair to say it does not have a heavy debt load!

Schaffer's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Schaffer can strengthen its balance sheet over time. 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. Schaffer 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, Schaffer recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.