Here's Why Northern Technologies International (NASDAQ:NTIC) Can Manage Its Debt Responsibly

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. We note that Northern Technologies International Corporation (NASDAQ:NTIC) does have debt on its balance sheet. 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 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 step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that NTIC is potentially overvalued!

What Is Northern Technologies International's Net Debt?

The image below, which you can click on for greater detail, shows that at May 2022 Northern Technologies International had debt of US$4.70m, up from none in one year. However, it does have US$6.13m in cash offsetting this, leading to net cash of US$1.43m.

How Healthy Is Northern Technologies International's Balance Sheet?

We can see from the most recent balance sheet that Northern Technologies International had liabilities of US$14.2m falling due within a year, and liabilities of US$2.27m due beyond that. On the other hand, it had cash of US$6.13m and US$16.4m worth of receivables due within a year. So it actually has US$5.97m more liquid assets than total liabilities.

This surplus suggests that Northern Technologies International has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Northern Technologies International boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Northern Technologies International turned things around in the last 12 months, delivering and EBIT of US$561k. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Northern Technologies International's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Northern Technologies International 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. During the last year, Northern Technologies International burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Northern Technologies International has US$1.43m in net cash and a decent-looking balance sheet. So we don't have any problem with Northern Technologies International's use of debt. 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. To that end, you should be aware of the 2 warning signs we've spotted with Northern Technologies International .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.