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. We can see that Franchise Brands plc (LON:FRAN) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Franchise Brands

What Is Franchise Brands's Net Debt?

As you can see below, Franchise Brands had UK£4.13m of debt at June 2021, down from UK£6.04m a year prior. However, it does have UK£12.2m in cash offsetting this, leading to net cash of UK£8.05m.

How Strong Is Franchise Brands' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Franchise Brands had liabilities of UK£14.6m due within 12 months and liabilities of UK£9.72m due beyond that. Offsetting these obligations, it had cash of UK£12.2m as well as receivables valued at UK£16.0m due within 12 months. So it actually has UK£3.89m 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. Succinctly put, Franchise Brands boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Franchise Brands grew its EBIT by 103% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Franchise Brands can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.