Is Proact IT Group (STO:PACT) Using Too Much 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.' 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, Proact IT Group AB (publ) (STO:PACT) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Proact IT Group

What Is Proact IT Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Proact IT Group had kr316.1m of debt, an increase on kr277.2m, over one year. But on the other hand it also has kr320.6m in cash, leading to a kr4.50m net cash position.

A Look At Proact IT Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Proact IT Group had liabilities of kr1.18b due within 12 months and liabilities of kr918.2m due beyond that. Offsetting these obligations, it had cash of kr320.6m as well as receivables valued at kr934.1m due within 12 months. So its liabilities total kr840.1m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Proact IT Group is worth kr2.07b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Proact IT Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Proact IT Group has increased its EBIT by 8.4% over twelve months, which should ease any concerns about debt repayment. 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 Proact IT Group 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. Proact IT 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. Happily for any shareholders, Proact IT Group actually produced more free cash flow than EBIT over the last three years. 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 Proact IT Group does have more liabilities than liquid assets, it also has net cash of kr4.50m. The cherry on top was that in converted 114% of that EBIT to free cash flow, bringing in kr106m. So we don't think Proact IT Group's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Proact IT Group that you should be aware of.

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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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.