These 4 Measures Indicate That Value Added Technology (KOSDAQ:043150) Is Using Debt Reasonably Well

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Value Added Technology Co., Ltd. (KOSDAQ:043150) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Value Added Technology

How Much Debt Does Value Added Technology Carry?

As you can see below, Value Added Technology had ₩27.7b of debt at September 2020, down from ₩31.6b a year prior. However, its balance sheet shows it holds ₩75.2b in cash, so it actually has ₩47.5b net cash.

How Healthy Is Value Added Technology's Balance Sheet?

The latest balance sheet data shows that Value Added Technology had liabilities of ₩68.2b due within a year, and liabilities of ₩45.1b falling due after that. Offsetting these obligations, it had cash of ₩75.2b as well as receivables valued at ₩45.3b due within 12 months. So it can boast ₩7.11b more liquid assets than total liabilities.

This state of affairs indicates that Value Added Technology's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₩454.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Value Added Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Value Added Technology's load is not too heavy, because its EBIT was down 32% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Value Added Technology 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. Value Added Technology 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. During the last three years, Value Added Technology generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case Value Added Technology has ₩47.5b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 93% of that EBIT to free cash flow, bringing in ₩35b. So we don't have any problem with Value Added Technology's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Value Added Technology that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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