Does Rotork (LON:ROR) Have A Healthy Balance Sheet?

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.' 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. As with many other companies Rotork plc (LON:ROR) makes use of debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Rotork

What Is Rotork's Debt?

As you can see below, at the end of December 2022, Rotork had UK£8.84m of debt, up from UK£725.0k a year ago. Click the image for more detail. But it also has UK£114.8m in cash to offset that, meaning it has UK£105.9m net cash.

A Look At Rotork's Liabilities

We can see from the most recent balance sheet that Rotork had liabilities of UK£119.0m falling due within a year, and liabilities of UK£23.0m due beyond that. Offsetting this, it had UK£114.8m in cash and UK£181.3m in receivables that were due within 12 months. So it can boast UK£154.0m more liquid assets than total liabilities.

This surplus suggests that Rotork has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Rotork has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Rotork grew its EBIT by 14% last year, making its debt load easier to handle. 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 Rotork's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Rotork 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, Rotork produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Rotork has UK£105.9m in net cash and a decent-looking balance sheet. So we don't think Rotork'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. For instance, we've identified 1 warning sign for Rotork that you should be aware of.

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.