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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Firan Technology Group Corporation (TSE:FTG) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Firan Technology Group Carry?
The image below, which you can click on for greater detail, shows that Firan Technology Group had debt of CA$6.61m at the end of May 2019, a reduction from CA$12.1m over a year. However, it also had CA$4.31m in cash, and so its net debt is CA$2.30m.
How Strong Is Firan Technology Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Firan Technology Group had liabilities of CA$20.1m due within 12 months and liabilities of CA$6.09m due beyond that. Offsetting this, it had CA$4.31m in cash and CA$22.3m in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
This state of affairs indicates that Firan Technology Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CA$83.6m company is struggling for cash, we still think it's worth monitoring its balance sheet.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Firan Technology Group's net debt is only 0.15 times its EBITDA. And its EBIT easily covers its interest expense, being 26.2 times the size. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Firan Technology Group grew its EBIT by 139% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Firan Technology Group 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Firan Technology Group recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Firan Technology Group's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Zooming out, Firan Technology Group seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. We'd be motivated to research the stock further if we found out that Firan Technology Group insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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.
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