Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Transcat, Inc. (NASDAQ:TRNS) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Transcat Carry?

The image below, which you can click on for greater detail, shows that Transcat had debt of US$3.00m at the end of September 2024, a reduction from US$53.3m over a year. But on the other hand it also has US$23.8m in cash, leading to a US$20.8m net cash position.

A Look At Transcat's Liabilities

We can see from the most recent balance sheet that Transcat had liabilities of US$26.5m falling due within a year, and liabilities of US$28.3m due beyond that. Offsetting these obligations, it had cash of US$23.8m as well as receivables valued at US$49.6m due within 12 months. So it can boast US$18.6m more liquid assets than total liabilities.

Having regard to Transcat's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$1.00b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Transcat boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Transcat grew its EBIT at 16% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Transcat can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Transcat 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. During the last three years, Transcat produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Transcat has net cash of US$20.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in US$17m. So we don't think Transcat's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Transcat , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.