Down Debt

These 4 measures indicate that Volution Group (LON:FAN) uses debt safely

Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that Volution Group plc (LON:FAN) uses debt in its business. But should shareholders worry about its use of debt?

When is debt dangerous?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. 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. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

Discover our latest analysis for Volution Group

What is Volution Group’s debt?

As you can see below, at the end of January 2022, Volution Group had a debt of £102.9m, up from £90.7m a year ago. Click on the image for more details. On the other hand, he has £15.2m in cash, resulting in a net debt of around £87.8m.

LSE: FAN Debt to Equity History April 7, 2022

How strong is Volution Group’s balance sheet?

Zooming in on the latest balance sheet data, we can see that Volution Group had liabilities of £65.1m due within 12 months and liabilities of £154.1m due beyond. As compensation for these obligations, it had cash of £15.2 million as well as receivables valued at £54.3 million maturing within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables of £149.8 million.

Given that publicly traded Volution Group shares are worth a total of £798.8 million, it seems unlikely that this level of liability is a major threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Volution Group has a low net debt to EBITDA ratio of just 1.3. And its EBIT covers its interest charges 13.6 times. So we’re pretty relaxed about his super-conservative use of debt. Even better, Volution Group increased its EBIT by 130% last year, which is an impressive improvement. This boost will make it even easier to pay off debt in the future. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Volution Group’s ability to maintain a healthy balance sheet in the future. 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. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Volution Group has actually produced more free cash flow than EBIT. There’s nothing better than incoming money to stay in the good books of your lenders.

Our point of view

Fortunately, Volution Group’s impressive interest coverage means it has the upper hand on its debt. And the good news doesn’t stop there, since its conversion of EBIT into free cash flow also confirms this impression! Given this range of factors, it seems to us that Volution Group is quite cautious with its leverage, and the risks seem well contained. The balance sheet therefore seems rather healthy to us. 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. Be aware that Volonté Group displays 2 warning signs in our investment analysis you should know…

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.

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.