Is Craneware (LON:CRW) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Craneware plc (LON:CRW) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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.

Check out our latest analysis for Craneware

What Is Craneware's Net Debt?

As you can see below, Craneware had US$35.4m of debt at June 2024, down from US$83.0m a year prior. On the flip side, it has US$34.6m in cash leading to net debt of about US$783.0k.

How Strong Is Craneware's Balance Sheet?

We can see from the most recent balance sheet that Craneware had liabilities of US$148.8m falling due within a year, and liabilities of US$66.3m due beyond that. Offsetting this, it had US$34.6m in cash and US$50.9m in receivables that were due within 12 months. So it has liabilities totalling US$129.6m more than its cash and near-term receivables, combined.

Since publicly traded Craneware shares are worth a total of US$1.02b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, Craneware has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Craneware's net debt to EBITDA ratio is very low, at 0.018, suggesting the debt is only trivial. But EBIT was only 5.1 times the interest expense last year, so the borrowing is clearly weighing on the business somewhat. Craneware grew its EBIT by 3.4% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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 Craneware 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Craneware actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Craneware's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its net debt to EBITDA also supports that impression! It's also worth noting that Craneware is in the Healthcare Services industry, which is often considered to be quite defensive. Zooming out, Craneware seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Craneware you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.