FormFactor (NASDAQ:FORM) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 FormFactor, Inc. (NASDAQ:FORM) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for FormFactor

How Much Debt Does FormFactor Carry?

You can click the graphic below for the historical numbers, but it shows that FormFactor had US$58.5m of debt in December 2019, down from US$64.8m, one year before. However, its balance sheet shows it holds US$220.9m in cash, so it actually has US$162.4m net cash.

A Look At FormFactor's Liabilities

The latest balance sheet data shows that FormFactor had liabilities of US$136.6m due within a year, and liabilities of US$62.3m falling due after that. Offsetting these obligations, it had cash of US$220.9m as well as receivables valued at US$98.8m due within 12 months. So it can boast US$120.8m more liquid assets than total liabilities.

This short term liquidity is a sign that FormFactor could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that FormFactor has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, FormFactor grew its EBIT by 40% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if FormFactor 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. FormFactor 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, FormFactor actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case FormFactor has US$162.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$100m, being 163% of its EBIT. So is FormFactor'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. Consider risks, for instance. Every company has them, and we've spotted 3 warning signs for FormFactor you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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