Here's Why Detection Technology Oyj (HEL:DETEC) Can Manage Its Debt Responsibly

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.' 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. Importantly, Detection Technology Oyj (HEL:DETEC) does carry debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Detection Technology Oyj

How Much Debt Does Detection Technology Oyj Carry?

As you can see below, Detection Technology Oyj had €5.82m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds €25.2m in cash, so it actually has €19.4m net cash.

A Look At Detection Technology Oyj's Liabilities

According to the balance sheet data, Detection Technology Oyj had liabilities of €17.3m due within 12 months, but no longer term liabilities. Offsetting these obligations, it had cash of €25.2m as well as receivables valued at €24.6m due within 12 months. So it actually has €32.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Detection Technology Oyj could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Detection Technology Oyj boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Detection Technology Oyj's saving grace is its low debt levels, because its EBIT has tanked 49% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Detection Technology Oyj can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Detection Technology Oyj 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. In the last three years, Detection Technology Oyj's free cash flow amounted to 30% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Detection Technology Oyj has €19.4m in net cash and a decent-looking balance sheet. So we don't have any problem with Detection Technology Oyj's use of debt. 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. Be aware that Detection Technology Oyj is showing 1 warning sign in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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