These 4 Measures Indicate That FormFactor (NASDAQ:FORM) Is Using Debt Safely

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. 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.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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.

View our latest analysis for FormFactor

What Is FormFactor's Debt?

As you can see below, FormFactor had US$13.6m of debt at September 2024, down from US$14.7m a year prior. However, its balance sheet shows it holds US$354.5m in cash, so it actually has US$340.9m net cash.

A Look At FormFactor's Liabilities

We can see from the most recent balance sheet that FormFactor had liabilities of US$129.2m falling due within a year, and liabilities of US$69.6m due beyond that. Offsetting these obligations, it had cash of US$354.5m as well as receivables valued at US$123.7m due within 12 months. So it can boast US$279.4m more liquid assets than total liabilities.

This surplus suggests that FormFactor has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, FormFactor 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, FormFactor turned things around in the last 12 months, delivering and EBIT of US$47m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine FormFactor'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. Over the last year, FormFactor actually produced more free cash flow than EBIT. 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$340.9m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$50m, being 107% 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. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for FormFactor you should be aware of, and 1 of them shouldn't be ignored.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.