These 4 Measures Indicate That Rectifier Technologies (ASX:RFT) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Rectifier Technologies Limited (ASX:RFT) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Rectifier Technologies

How Much Debt Does Rectifier Technologies Carry?

As you can see below, Rectifier Technologies had AU$2.50m of debt at December 2020, down from AU$2.75m a year prior. However, it does have AU$5.49m in cash offsetting this, leading to net cash of AU$2.99m.

How Healthy Is Rectifier Technologies' Balance Sheet?

According to the last reported balance sheet, Rectifier Technologies had liabilities of AU$2.84m due within 12 months, and liabilities of AU$3.71m due beyond 12 months. On the other hand, it had cash of AU$5.49m and AU$1.87m worth of receivables due within a year. So it can boast AU$804.9k more liquid assets than total liabilities.

Having regard to Rectifier Technologies' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the AU$50.9m company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Rectifier Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Rectifier Technologies's load is not too heavy, because its EBIT was down 56% 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 Rectifier Technologies's earnings that will influence how the balance sheet holds up in the future. 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, a company can only pay off debt with cold hard cash, not accounting profits. While Rectifier Technologies 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. During the last three years, Rectifier Technologies produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Rectifier Technologies has net cash of AU$2.99m, as well as more liquid assets than liabilities. So we don't have any problem with Rectifier Technologies'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 Rectifier Technologies is showing 3 warning signs in our investment analysis , you should know about...

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 decide to trade Rectifier Technologies, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.