FORTEC Elektronik (ETR:FEV) Seems To Use Debt Rather Sparingly

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.' 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 note that FORTEC Elektronik AG (ETR:FEV) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for FORTEC Elektronik

What Is FORTEC Elektronik's Debt?

You can click the graphic below for the historical numbers, but it shows that FORTEC Elektronik had €1.44m of debt in December 2023, down from €1.78m, one year before. But on the other hand it also has €18.5m in cash, leading to a €17.1m net cash position.

A Look At FORTEC Elektronik's Liabilities

We can see from the most recent balance sheet that FORTEC Elektronik had liabilities of €12.2m falling due within a year, and liabilities of €6.19m due beyond that. Offsetting these obligations, it had cash of €18.5m as well as receivables valued at €9.96m due within 12 months. So it can boast €10.1m more liquid assets than total liabilities.

This surplus suggests that FORTEC Elektronik is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, FORTEC Elektronik boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, FORTEC Elektronik grew its EBIT by 44% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if FORTEC Elektronik can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 67% 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 it is always sensible to investigate a company's debt, in this case FORTEC Elektronik has €17.1m in net cash and a decent-looking balance sheet. And we liked the look of last year's 44% year-on-year EBIT growth. So is FORTEC Elektronik's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for FORTEC Elektronik you should be aware of, and 1 of them shouldn't be ignored.

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. 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.