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. Importantly, Tecsys Inc. (TSE:TCS) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
What Is Tecsys's Debt?
The image below, which you can click on for greater detail, shows that Tecsys had debt of CA$8.40m at the end of April 2022, a reduction from CA$9.62m over a year. But it also has CA$43.2m in cash to offset that, meaning it has CA$34.8m net cash.
How Healthy Is Tecsys' Balance Sheet?
We can see from the most recent balance sheet that Tecsys had liabilities of CA$43.5m falling due within a year, and liabilities of CA$13.6m due beyond that. Offsetting these obligations, it had cash of CA$43.2m as well as receivables valued at CA$24.0m due within 12 months. So it can boast CA$10.1m more liquid assets than total liabilities.
This surplus suggests that Tecsys has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Tecsys boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Tecsys's load is not too heavy, because its EBIT was down 50% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Tecsys'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. While Tecsys 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, Tecsys actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While we empathize with investors who find debt concerning, you should keep in mind that Tecsys has net cash of CA$34.8m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CA$4.0m, being 144% of its EBIT. So we don't have any problem with Tecsys's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Tecsys is showing 1 warning sign in our investment analysis , you should know about...
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.
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