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Is Rank Group (LON:RNK) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 The Rank Group Plc (LON:RNK) does use debt in its business. But should shareholders be worried about its use of debt?

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 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Rank Group

What Is Rank Group's Net Debt?

The image below, which you can click on for greater detail, shows that Rank Group had debt of UK£78.0m at the end of June 2022, a reduction from UK£117.1m over a year. However, its balance sheet shows it holds UK£97.9m in cash, so it actually has UK£19.9m net cash.

debt-equity-history-analysis
debt-equity-history-analysis

How Strong Is Rank Group's Balance Sheet?

The latest balance sheet data shows that Rank Group had liabilities of UK£216.5m due within a year, and liabilities of UK£215.1m falling due after that. On the other hand, it had cash of UK£97.9m and UK£42.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£291.4m.

This is a mountain of leverage relative to its market capitalization of UK£394.4m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Rank Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Rank Group turned things around in the last 12 months, delivering and EBIT of UK£82m. 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 Rank Group 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Rank Group 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 year, Rank Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Rank Group does have more liabilities than liquid assets, it also has net cash of UK£19.9m. And it impressed us with free cash flow of UK£115m, being 139% of its EBIT. So we don't have any problem with Rank Group's use of debt. 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 Rank Group , 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.

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