Is FW Thorpe (LON:TFW) Using Too Much Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies FW Thorpe Plc (LON:TFW) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for FW Thorpe

What Is FW Thorpe's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 FW Thorpe had UK£11.1m of debt, an increase on UK£73.0k, over one year. However, it does have UK£41.0m in cash offsetting this, leading to net cash of UK£30.0m.

How Healthy Is FW Thorpe's Balance Sheet?

We can see from the most recent balance sheet that FW Thorpe had liabilities of UK£34.5m falling due within a year, and liabilities of UK£16.8m due beyond that. Offsetting these obligations, it had cash of UK£41.0m as well as receivables valued at UK£29.7m due within 12 months. So it actually has UK£19.4m more liquid assets than total liabilities.

This surplus suggests that FW Thorpe has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, FW Thorpe boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that FW Thorpe has seen its EBIT plunge 13% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is FW Thorpe'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. FW Thorpe 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. Over the most recent three years, FW Thorpe recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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 FW Thorpe has net cash of UK£30.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of UK£18m, being 71% of its EBIT. So we don't have any problem with FW Thorpe'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. For example - FW Thorpe has 3 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.