FORTEC Elektronik (ETR:FEV) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that FORTEC Elektronik AG (ETR:FEV) does use debt in its business. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for FORTEC Elektronik

What Is FORTEC Elektronik's Debt?

The image below, which you can click on for greater detail, shows that FORTEC Elektronik had debt of €3.82m at the end of March 2021, a reduction from €4.99m over a year. However, it does have €13.2m in cash offsetting this, leading to net cash of €9.38m.

How Healthy Is FORTEC Elektronik's Balance Sheet?

According to the last reported balance sheet, FORTEC Elektronik had liabilities of €11.3m due within 12 months, and liabilities of €8.21m due beyond 12 months. Offsetting this, it had €13.2m in cash and €10.1m in receivables that were due within 12 months. So it can boast €3.82m more liquid assets than total liabilities.

This short term liquidity is a sign that FORTEC Elektronik could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that FORTEC Elektronik has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, FORTEC Elektronik grew its EBIT by 4.6% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine FORTEC Elektronik'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. FORTEC Elektronik 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, FORTEC Elektronik produced sturdy free cash flow equating to 63% 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 FORTEC Elektronik has net cash of €9.38m, as well as more liquid assets than liabilities. So we don't think FORTEC Elektronik's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for FORTEC Elektronik 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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