Does Formpipe Software (STO:FPIP) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Formpipe Software AB (publ) (STO:FPIP) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Formpipe Software

What Is Formpipe Software's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Formpipe Software had debt of kr36.6m, up from kr5.94m in one year. However, its balance sheet shows it holds kr58.6m in cash, so it actually has kr22.0m net cash.

A Look At Formpipe Software's Liabilities

We can see from the most recent balance sheet that Formpipe Software had liabilities of kr250.5m falling due within a year, and liabilities of kr71.1m due beyond that. Offsetting this, it had kr58.6m in cash and kr101.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr161.2m.

Of course, Formpipe Software has a market capitalization of kr1.53b, 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, Formpipe Software also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also good is that Formpipe Software grew its EBIT at 11% over the last year, further increasing its ability to manage debt. 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 Formpipe Software 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Formpipe Software 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. Over the last three years, Formpipe Software actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While Formpipe Software does have more liabilities than liquid assets, it also has net cash of kr22.0m. The cherry on top was that in converted 111% of that EBIT to free cash flow, bringing in kr69m. So is Formpipe Software's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with Formpipe Software .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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