Here's Why SFA Engineering (KOSDAQ:056190) Can Manage Its Debt Responsibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that SFA Engineering Corporation (KOSDAQ:056190) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for SFA Engineering

How Much Debt Does SFA Engineering Carry?

The image below, which you can click on for greater detail, shows that SFA Engineering had debt of ₩146.6b at the end of September 2020, a reduction from ₩239.1b over a year. But it also has ₩337.9b in cash to offset that, meaning it has ₩191.3b net cash.

A Look At SFA Engineering's Liabilities

The latest balance sheet data shows that SFA Engineering had liabilities of ₩336.5b due within a year, and liabilities of ₩153.5b falling due after that. Offsetting these obligations, it had cash of ₩337.9b as well as receivables valued at ₩285.5b due within 12 months. So it can boast ₩133.4b more liquid assets than total liabilities.

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

SFA Engineering'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 ultimately the future profitability of the business will decide if SFA Engineering 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, a company can only pay off debt with cold hard cash, not accounting profits. While SFA Engineering 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. Looking at the most recent three years, SFA Engineering recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case SFA Engineering has ₩191.3b in net cash and a decent-looking balance sheet. So we don't have any problem with SFA Engineering's use of debt. 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. Take risks, for example - SFA Engineering has 1 warning sign we think 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.

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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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