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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that Rectifier Technologies Limited (ASX:RFT) does use debt in its business. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Rectifier Technologies

How Much Debt Does Rectifier Technologies Carry?

The image below, which you can click on for greater detail, shows that at June 2022 Rectifier Technologies had debt of AU$5.27m, up from AU$2.59m in one year. However, its balance sheet shows it holds AU$7.30m in cash, so it actually has AU$2.02m net cash.

How Strong Is Rectifier Technologies' Balance Sheet?

We can see from the most recent balance sheet that Rectifier Technologies had liabilities of AU$8.63m falling due within a year, and liabilities of AU$4.98m due beyond that. Offsetting this, it had AU$7.30m in cash and AU$3.64m in receivables that were due within 12 months. So its liabilities total AU$2.67m more than the combination of its cash and short-term receivables.

Since publicly traded Rectifier Technologies shares are worth a total of AU$44.0m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Rectifier Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Rectifier Technologies grew its EBIT by 29% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. 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. Over the last three years, Rectifier Technologies recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

We could understand if investors are concerned about Rectifier Technologies's liabilities, but we can be reassured by the fact it has has net cash of AU$2.02m. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in -AU$1.4m. So is Rectifier Technologies's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Rectifier Technologies you should be aware of, and 1 of them is concerning.

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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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.