Formula Systems (1985) (TLV:FORTY) Has A Pretty Healthy Balance Sheet

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.' 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 Formula Systems (1985) Ltd. (TLV:FORTY) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Formula Systems (1985)

What Is Formula Systems (1985)'s Net Debt?

The image below, which you can click on for greater detail, shows that Formula Systems (1985) had debt of US$472.7m at the end of June 2024, a reduction from US$605.5m over a year. But it also has US$472.9m in cash to offset that, meaning it has US$205.0k net cash.

A Look At Formula Systems (1985)'s Liabilities

According to the last reported balance sheet, Formula Systems (1985) had liabilities of US$931.7m due within 12 months, and liabilities of US$444.0m due beyond 12 months. Offsetting this, it had US$472.9m in cash and US$710.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$192.5m.

Of course, Formula Systems (1985) has a market capitalization of US$1.26b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Formula Systems (1985) boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Formula Systems (1985) grew its EBIT by 3.3% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Formula Systems (1985) will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Formula Systems (1985) has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Formula Systems (1985) recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Formula Systems (1985) does have more liabilities than liquid assets, it also has net cash of US$205.0k. So we are not troubled with Formula Systems (1985)'s debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Formula Systems (1985), you may well want to click here to check an interactive graph of its earnings per share history.

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.