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These 4 Measures Indicate That Teradyne (NASDAQ:TER) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Teradyne, Inc. (NASDAQ:TER) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

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See our latest analysis for Teradyne

What Is Teradyne's Debt?

The chart below, which you can click on for greater detail, shows that Teradyne had US$394.7m in debt in December 2019; about the same as the year before. However, its balance sheet shows it holds US$911.2m in cash, so it actually has US$516.5m net cash.

NasdaqGS:TER Historical Debt, February 11th 2020
NasdaqGS:TER Historical Debt, February 11th 2020

How Healthy Is Teradyne's Balance Sheet?

We can see from the most recent balance sheet that Teradyne had liabilities of US$539.0m falling due within a year, and liabilities of US$765.5m due beyond that. On the other hand, it had cash of US$911.2m and US$362.4m worth of receivables due within a year. So it has liabilities totalling US$30.9m more than its cash and near-term receivables, combined.

Having regard to Teradyne's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$12.1b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Teradyne also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Teradyne has increased its EBIT by 8.3% over twelve months, which should ease any concerns about debt repayment. 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 Teradyne 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Teradyne 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, Teradyne generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Teradyne has US$516.5m in net cash. And it impressed us with free cash flow of US$444m, being 85% of its EBIT. So is Teradyne's debt a risk? It doesn't seem so to us. We'd be very excited to see if Teradyne insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.