Here's Why Cass Information Systems (NASDAQ:CASS) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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 Cass Information Systems, Inc. (NASDAQ:CASS) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Cass Information Systems

How Much Debt Does Cass Information Systems Carry?

As you can see below, at the end of December 2019, Cass Information Systems had US$18.0m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has US$204.0m in cash, leading to a US$186.0m net cash position.

A Look At Cass Information Systems's Liabilities

The latest balance sheet data shows that Cass Information Systems had liabilities of US$1.43b due within a year, and liabilities of US$95.0m falling due after that. Offsetting these obligations, it had cash of US$204.0m as well as receivables valued at US$762.1m due within 12 months. So it has liabilities totalling US$554.0m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of US$486.0m, we think shareholders really should watch Cass Information Systems's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Cass Information Systems boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Fortunately, Cass Information Systems grew its EBIT by 6.4% in the last year, making that debt load look even more manageable. 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 Cass Information Systems 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Cass Information Systems 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 three years, Cass Information Systems recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

Although Cass Information Systems's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$186.0m. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in US$39m. So we are not troubled with Cass Information Systems's debt use. 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 1 warning sign we've spotted with Cass Information Systems .

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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