Does Franchise Brands (LON:FRAN) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Franchise Brands plc (LON:FRAN) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Franchise Brands

What Is Franchise Brands's Net Debt?

The image below, which you can click on for greater detail, shows that Franchise Brands had debt of UK£5.11m at the end of December 2020, a reduction from UK£9.27m over a year. But it also has UK£13.2m in cash to offset that, meaning it has UK£8.10m net cash.

How Strong Is Franchise Brands' Balance Sheet?

We can see from the most recent balance sheet that Franchise Brands had liabilities of UK£14.4m falling due within a year, and liabilities of UK£10.3m due beyond that. On the other hand, it had cash of UK£13.2m and UK£15.1m worth of receivables due within a year. So it can boast UK£3.57m more liquid assets than total liabilities.

This surplus suggests that Franchise Brands has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Franchise Brands has more cash than debt is arguably a good indication that it can manage its debt safely.

Franchise Brands's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. But it is Franchise Brands's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Franchise Brands 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. During the last three years, Franchise Brands generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Franchise Brands has net cash of UK£8.10m, as well as more liquid assets than liabilities. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in UK£4.5m. So we don't think Franchise Brands's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Franchise Brands that you should be aware of.

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.

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. 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.

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