Is Terranet (STO:TERRNT B) Using Debt Sensibly?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Terranet AB (STO:TERRNT B) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Terranet

How Much Debt Does Terranet Carry?

As you can see below, Terranet had kr16.4m of debt at June 2023, down from kr30.7m a year prior. However, its balance sheet shows it holds kr22.4m in cash, so it actually has kr5.97m net cash.

A Look At Terranet's Liabilities

According to the last reported balance sheet, Terranet had liabilities of kr24.4m due within 12 months, and liabilities of kr2.79m due beyond 12 months. On the other hand, it had cash of kr22.4m and kr14.4m worth of receivables due within a year. So it actually has kr9.61m more liquid assets than total liabilities.

This short term liquidity is a sign that Terranet could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Terranet has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Terranet will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Terranet had a loss before interest and tax, and actually shrunk its revenue by 61%, to kr2.6m. To be frank that doesn't bode well.

So How Risky Is Terranet?

Statistically speaking companies that lose money are riskier than those that make money. And in the last year Terranet had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through kr36m of cash and made a loss of kr37m. Given it only has net cash of kr5.97m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Terranet is showing 5 warning signs in our investment analysis , you should know about...

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.

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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.