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.' 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. As with many other companies Transcat, Inc. (NASDAQ:TRNS) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Transcat Carry?

You can click the graphic below for the historical numbers, but it shows that Transcat had US$3.58m of debt in June 2024, down from US$48.4m, one year before. But it also has US$22.7m in cash to offset that, meaning it has US$19.1m net cash.

How Healthy Is Transcat's Balance Sheet?

According to the last reported balance sheet, Transcat had liabilities of US$31.8m due within 12 months, and liabilities of US$29.6m due beyond 12 months. Offsetting this, it had US$22.7m in cash and US$48.4m in receivables that were due within 12 months. So it can boast US$9.69m 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 it's very unlikely that the US$1.06b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Transcat boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Transcat grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. 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 Transcat'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Transcat has net cash of US$19.1m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 25% over the last year. So we don't think Transcat's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Transcat that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.