David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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 note that Knowit AB (publ) (STO:KNOW) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.
View our latest analysis for Knowit
What Is Knowit’s Debt?
As you can see below, Knowit had kr66.7m of debt at December 2019, down from kr81.6m a year prior. But on the other hand it also has kr278.4m in cash, leading to a kr211.7m net cash position.
How Strong Is Knowit’s Balance Sheet?
We can see from the most recent balance sheet that Knowit had liabilities of kr770.0m falling due within a year, and liabilities of kr215.1m due beyond that. Offsetting these obligations, it had cash of kr278.4m as well as receivables valued at kr718.5m due within 12 months. So these liquid assets roughly match the total liabilities.
Having regard to Knowit’s size, it seems that its liquid assets are well balanced with its total liabilities. So while it’s hard to imagine that the kr2.48b company is struggling for cash, we still think it’s worth monitoring its balance sheet. Simply put, the fact that Knowit has more cash than debt is arguably a good indication that it can manage its debt safely.
While Knowit doesn’t seem to have gained much on the EBIT line, at least earnings remain stable for now. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Knowit can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. While Knowit 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. Over the last three years, Knowit recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that Knowit has net cash of kr211.7m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of kr305m, being 83% of its EBIT. So we don’t think Knowit’s use of debt is risky. 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. Be aware that Knowit is showing 1 warning sign in our investment analysis , you should know about…
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.
If you spot an error that warrants correction, please contact the editor at [email protected] This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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