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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. 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 A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Rectifier Technologies

What Is Rectifier Technologies's Net Debt?

The chart below, which you can click on for greater detail, shows that Rectifier Technologies had AU$2.49m in debt in December 2022; about the same as the year before. However, it does have AU$7.89m in cash offsetting this, leading to net cash of AU$5.40m.

How Healthy Is Rectifier Technologies' Balance Sheet?

According to the last reported balance sheet, Rectifier Technologies had liabilities of AU$12.6m due within 12 months, and liabilities of AU$3.65m due beyond 12 months. Offsetting these obligations, it had cash of AU$7.89m as well as receivables valued at AU$5.99m due within 12 months. So its liabilities total AU$2.33m more than the combination of its cash and short-term receivables.

Of course, Rectifier Technologies has a market capitalization of AU$66.0m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Rectifier Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Rectifier Technologies grew its EBIT by 950% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Rectifier Technologies will need earnings to service that debt. 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. Rectifier Technologies may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Rectifier Technologies produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

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$5.40m. And we liked the look of last year's 950% year-on-year EBIT growth. So we don't think Rectifier Technologies's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Rectifier Technologies has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.