We Think FormFactor (NASDAQ:FORM) Can Manage Its Debt With Ease

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.' 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 note that FormFactor, Inc. (NASDAQ:FORM) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for FormFactor

What Is FormFactor's Debt?

You can click the graphic below for the historical numbers, but it shows that FormFactor had US$15.4m of debt in December 2022, down from US$24.4m, one year before. However, it does have US$238.1m in cash offsetting this, leading to net cash of US$222.7m.

How Healthy Is FormFactor's Balance Sheet?

The latest balance sheet data shows that FormFactor had liabilities of US$149.7m due within a year, and liabilities of US$50.3m falling due after that. Offsetting these obligations, it had cash of US$238.1m as well as receivables valued at US$88.1m due within 12 months. So it can boast US$126.3m 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.

Also good is that FormFactor grew its EBIT at 16% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While FormFactor has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, FormFactor generated free cash flow amounting to a very robust 88% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that FormFactor has net cash of US$222.7m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$67m, being 88% of its EBIT. So we don't think FormFactor's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for FormFactor that you should be aware of before investing here.

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.