Relatech (BIT:RLT) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, '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. Importantly, Relatech S.p.A. (BIT:RLT) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Relatech

How Much Debt Does Relatech Carry?

As you can see below, at the end of December 2020, Relatech had €4.63m of debt, up from €1.77m a year ago. Click the image for more detail. However, its balance sheet shows it holds €8.27m in cash, so it actually has €3.64m net cash.

How Healthy Is Relatech's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Relatech had liabilities of €7.28m due within 12 months and liabilities of €9.78m due beyond that. On the other hand, it had cash of €8.27m and €7.89m worth of receivables due within a year. So its liabilities total €903.9k more than the combination of its cash and short-term receivables.

Having regard to Relatech's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the €80.0m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Relatech also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Relatech's EBIT dived 10%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Relatech'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 company can only pay off debt with cold hard cash, not accounting profits. Relatech 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. Looking at the most recent three years, Relatech recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Relatech has €3.64m in net cash. So we are not troubled with Relatech's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Relatech has 2 warning signs we think 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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