Does Rakon (NZSE:RAK) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Rakon Limited (NZSE:RAK) does have debt on its balance sheet. 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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Rakon

What Is Rakon's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Rakon had NZ$4.49m of debt in September 2023, down from NZ$7.34m, one year before. But it also has NZ$17.9m in cash to offset that, meaning it has NZ$13.4m net cash.

A Look At Rakon's Liabilities

According to the last reported balance sheet, Rakon had liabilities of NZ$32.9m due within 12 months, and liabilities of NZ$10.4m due beyond 12 months. Offsetting these obligations, it had cash of NZ$17.9m as well as receivables valued at NZ$46.2m due within 12 months. So it actually has NZ$20.8m more liquid assets than total liabilities.

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

The modesty of its debt load may become crucial for Rakon if management cannot prevent a repeat of the 67% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Rakon 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Rakon 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. In the last three years, Rakon's free cash flow amounted to 30% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Rakon has NZ$13.4m in net cash and a decent-looking balance sheet. So we don't have any problem with Rakon's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Rakon (1 is concerning!) that you should be aware of before investing here.

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.

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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.