David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Above all, Proact IT Group AB (publisher) (STO:PACT) is in debt. But the real question is whether this debt makes the business risky.

Why is debt risky?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies 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.

Discover our latest analysis for Proact IT Group

What is Proact IT Group’s net debt?

You can click on the graph below for historical figures, but it shows that in September 2021, Proact IT Group had a debt of 316.1 million kr, an increase from 277.2 million kr, on a year. But on the other hand, he also has 320.6 million kr in cash, resulting in a net cash position of 4.50 million kr.

A look at the responsibilities of Proact IT Group

Zooming in on the latest balance sheet data, we can see that Proact IT Group had liabilities of 1.18 billion kr due within 12 months and liabilities of 918.2 million kr due beyond. In compensation for these obligations, it had cash of 320.6 million kr as well as receivables valued at 934.1 million kr and payable within 12 months. Thus, its liabilities total kr 840.1 million more than the combination of its cash and short-term receivables.

This shortfall is not that bad as Proact IT Group is worth 2.07 billion kr, and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But it is clear that it is essential to examine closely whether it can manage its debt without dilution. While it has liabilities to note, Proact IT Group also has more cash than debt, so we’re pretty confident it can manage its debt safely.

The good news is that Proact IT Group increased its EBIT by 8.4% year-over-year, which should ease any concerns about debt repayment. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Proact IT Group can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a company can only repay its debts with cold hard cash, not with book profits. Proact IT Group may have net cash on the balance sheet, but it’s always interesting to see how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its needs and its ability to manage debt. Fortunately for all shareholders, Proact IT Group has actually produced more free cash flow than EBIT for the past three years. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summary

Although Proact IT Group has more liabilities than liquid assets, it also has a net cash position of 4.50 million kr. The icing on the cake was to convert 114% of this EBIT into free cash flow, which brought in 106 million kr. We therefore do not believe that Proact IT Group’s use of debt is risky. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 1 warning sign for Proact IT Group of which you should be aware.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.