Napatech (OB:NAPA) Has A Rock Solid Balance Sheet

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. 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. We can see that Napatech A/S (OB:NAPA) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View 3 warning signs we detected for Napatech

What Is Napatech's Debt?

The image below, which you can click on for greater detail, shows that at September 2019 Napatech had debt of ø31.8m, up from ø40.5 in one year. But it also has ø53.1m in cash to offset that, meaning it has ø21.3m net cash.

How Healthy Is Napatech's Balance Sheet?

The latest balance sheet data shows that Napatech had liabilities of ø61.5m due within a year, and liabilities of ø21.3m falling due after that. On the other hand, it had cash of ø53.1m and ø38.9m worth of receivables due within a year. So it actually has ø9.12m more liquid assets than total liabilities.

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

It was also good to see that despite losing money on the EBIT line last year, Napatech turned things around in the last 12 months, delivering and EBIT of ø12m. 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 example, we've discovered 3 warning signs for Napatech (of which 1 is major) which any shareholder or potential investor should be aware of.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Napatech 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, Napatech actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case Napatech has ø21.3m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in ø12m. So we don't think Napatech's use of debt is risky. We'd be very excited to see if Napatech insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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