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.' 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. We note that MSL Solutions Limited (ASX:MSL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for MSL Solutions

What Is MSL Solutions's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 MSL Solutions had debt of AU$3.79m, up from AU$2.45m in one year. But on the other hand it also has AU$7.80m in cash, leading to a AU$4.01m net cash position.

A Look At MSL Solutions' Liabilities

The latest balance sheet data shows that MSL Solutions had liabilities of AU$12.3m due within a year, and liabilities of AU$11.4m falling due after that. On the other hand, it had cash of AU$7.80m and AU$4.73m worth of receivables due within a year. So its liabilities total AU$11.2m more than the combination of its cash and short-term receivables.

Given MSL Solutions has a market capitalization of AU$74.7m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, MSL Solutions boasts net cash, so it's fair to say it does not have a heavy debt load!

Notably, MSL Solutions made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$1.4m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is MSL Solutions's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While MSL Solutions 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. Happily for any shareholders, MSL Solutions actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While MSL Solutions does have more liabilities than liquid assets, it also has net cash of AU$4.01m. And it impressed us with free cash flow of AU$3.8m, being 267% of its EBIT. So we are not troubled with MSL Solutions's debt use. 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. For example, we've discovered 3 warning signs for MSL Solutions that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.