We Think IAR Systems Group (STO:IAR B) Can Stay On Top Of Its Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that IAR Systems Group AB (publ) (STO:IAR B) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 IAR Systems Group

What Is IAR Systems Group's Net Debt?

The chart below, which you can click on for greater detail, shows that IAR Systems Group had kr17.9m in debt in June 2021; about the same as the year before. But it also has kr72.2m in cash to offset that, meaning it has kr54.3m net cash.

How Strong Is IAR Systems Group's Balance Sheet?

We can see from the most recent balance sheet that IAR Systems Group had liabilities of kr161.1m falling due within a year, and liabilities of kr58.1m due beyond that. Offsetting these obligations, it had cash of kr72.2m as well as receivables valued at kr62.3m due within 12 months. So its liabilities total kr84.7m more than the combination of its cash and short-term receivables.

Given IAR Systems Group has a market capitalization of kr1.65b, it's hard to believe these liabilities pose much threat. 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, IAR Systems Group boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for IAR Systems Group if management cannot prevent a repeat of the 26% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine IAR Systems Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. IAR Systems Group 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. In the last three years, IAR Systems Group's free cash flow amounted to 32% of its EBIT, less 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 IAR Systems Group has kr54.3m in net cash. So we don't have any problem with IAR Systems Group's use of debt. We'd be motivated to research the stock further if we found out that IAR Systems Group insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.
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