SP SystemsLtd (KOSDAQ:317830) Has A Somewhat Strained Balance Sheet

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. As with many other companies SP Systems Co.,Ltd. (KOSDAQ:317830) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for SP SystemsLtd

What Is SP SystemsLtd's Debt?

The image below, which you can click on for greater detail, shows that SP SystemsLtd had debt of ₩9.87b at the end of September 2020, a reduction from ₩12.8b over a year. However, its balance sheet shows it holds ₩15.9b in cash, so it actually has ₩6.03b net cash.

A Look At SP SystemsLtd's Liabilities

We can see from the most recent balance sheet that SP SystemsLtd had liabilities of ₩17.8b falling due within a year, and liabilities of ₩6.64b due beyond that. On the other hand, it had cash of ₩15.9b and ₩6.24b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩2.34b.

Given SP SystemsLtd has a market capitalization of ₩46.9b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, SP SystemsLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

Shareholders should be aware that SP SystemsLtd's EBIT was down 97% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is SP SystemsLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. SP SystemsLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent two years, SP SystemsLtd recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that SP SystemsLtd has ₩6.03b in net cash. So although we see some areas for improvement, we're not too worried about SP SystemsLtd's balance sheet. 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 example, we've discovered 3 warning signs for SP SystemsLtd (1 is a bit concerning!) that you should be aware of before investing here.

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.

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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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