Is Funtastic (ASX:FUN) Using Debt In A Risky Way?

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 note that Funtastic Limited (ASX:FUN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Funtastic

What Is Funtastic's Net Debt?

As you can see below, Funtastic had AU$3.27m of debt at January 2021, down from AU$7.95m a year prior. However, it does have AU$20.5m in cash offsetting this, leading to net cash of AU$17.2m.

How Strong Is Funtastic's Balance Sheet?

The latest balance sheet data shows that Funtastic had liabilities of AU$10.3m due within a year, and liabilities of AU$434.0k falling due after that. Offsetting this, it had AU$20.5m in cash and AU$6.49m in receivables that were due within 12 months. So it actually has AU$16.2m more liquid assets than total liabilities.

It's good to see that Funtastic has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Funtastic boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Funtastic'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.

In the last year Funtastic had a loss before interest and tax, and actually shrunk its revenue by 4.6%, to AU$27m. We would much prefer see growth.

So How Risky Is Funtastic?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Funtastic had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of AU$3.4m and booked a AU$4.4m accounting loss. With only AU$17.2m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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. To that end, you should learn about the 3 warning signs we've spotted with Funtastic (including 1 which is potentially serious) .

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. 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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