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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that CTS Corporation (NYSE:CTS) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does CTS Carry?

As you can see below, CTS had US$67.5m of debt at March 2024, down from US$80.9m a year prior. But it also has US$163.6m in cash to offset that, meaning it has US$96.1m net cash.

How Strong Is CTS' Balance Sheet?

The latest balance sheet data shows that CTS had liabilities of US$95.9m due within a year, and liabilities of US$115.6m falling due after that. Offsetting this, it had US$163.6m in cash and US$80.7m in receivables that were due within 12 months. So it can boast US$32.7m more liquid assets than total liabilities.

This surplus suggests that CTS has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, CTS boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact CTS's saving grace is its low debt levels, because its EBIT has tanked 23% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 CTS's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. While CTS 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, CTS recorded free cash flow worth a fulsome 97% 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

While we empathize with investors who find debt concerning, you should keep in mind that CTS has net cash of US$96.1m, as well as more liquid assets than liabilities. The cherry on top was that in converted 97% of that EBIT to free cash flow, bringing in US$82m. So we don't have any problem with CTS's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in CTS, you may well want to click here to check an interactive graph of its earnings per share history.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.