These 4 Measures Indicate That Heerim Architects & Planners (KOSDAQ:037440) 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.' 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 can see that Heerim Architects & Planners Co., Ltd. (KOSDAQ:037440) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Heerim Architects & Planners

What Is Heerim Architects & Planners's Debt?

The image below, which you can click on for greater detail, shows that Heerim Architects & Planners had debt of ₩36.5b at the end of September 2020, a reduction from ₩42.4b over a year. However, it does have ₩26.2b in cash offsetting this, leading to net debt of about ₩10.3b.

How Healthy Is Heerim Architects & Planners' Balance Sheet?

The latest balance sheet data shows that Heerim Architects & Planners had liabilities of ₩93.4b due within a year, and liabilities of ₩16.1b falling due after that. Offsetting this, it had ₩26.2b in cash and ₩75.7b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩7.56b.

Since publicly traded Heerim Architects & Planners shares are worth a total of ₩53.7b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 0.80 and interest cover of 4.2 times, it seems to us that Heerim Architects & Planners is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. It is well worth noting that Heerim Architects & Planners's EBIT shot up like bamboo after rain, gaining 33% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Heerim Architects & Planners's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Heerim Architects & Planners actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Heerim Architects & Planners's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its interest cover. Looking at the bigger picture, we think Heerim Architects & Planners's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. For example, we've discovered 2 warning signs for Heerim Architects & Planners that you should be aware of before investing here.

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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