Is Knowles (NYSE:KN) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Knowles Corporation (NYSE:KN) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Knowles

How Much Debt Does Knowles Carry?

You can click the graphic below for the historical numbers, but it shows that Knowles had US$45.0m of debt in December 2022, down from US$70.0m, one year before. However, it does have US$48.2m in cash offsetting this, leading to net cash of US$3.20m.

How Strong Is Knowles' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Knowles had liabilities of US$99.1m due within 12 months and liabilities of US$91.9m due beyond that. Offsetting this, it had US$48.2m in cash and US$134.7m in receivables that were due within 12 months. So its liabilities total US$8.10m more than the combination of its cash and short-term receivables.

Having regard to Knowles' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$1.51b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Knowles also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Knowles if management cannot prevent a repeat of the 21% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Knowles'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Knowles 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, Knowles actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

We could understand if investors are concerned about Knowles's liabilities, but we can be reassured by the fact it has has net cash of US$3.20m. And it impressed us with free cash flow of US$54m, being 106% of its EBIT. So we are not troubled with Knowles's debt use. Even though Knowles lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.