These 4 Measures Indicate That Touchstar (LON:TST) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Touchstar plc (LON:TST) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Touchstar

What Is Touchstar's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Touchstar had debt of UK£1.18m, up from UK£1.10m in one year. However, its balance sheet shows it holds UK£2.48m in cash, so it actually has UK£1.30m net cash.

How Strong Is Touchstar's Balance Sheet?

The latest balance sheet data shows that Touchstar had liabilities of UK£3.51m due within a year, and liabilities of UK£840.0k falling due after that. Offsetting this, it had UK£2.48m in cash and UK£1.25m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£613.0k.

Of course, Touchstar has a market capitalization of UK£6.23m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Touchstar also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Touchstar made a loss at the EBIT level, last year, it was also good to see that it generated UK£96k in EBIT over the last twelve months. 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 Touchstar 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. Touchstar 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. Happily for any shareholders, Touchstar actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Touchstar has UK£1.30m in net cash. The cherry on top was that in converted 178% of that EBIT to free cash flow, bringing in UK£171k. So we don't think Touchstar's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Touchstar (1 can't be ignored) you should be aware of.

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.

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.

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