YG Entertainment (KOSDAQ:122870) Has A Somewhat Strained Balance Sheet

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies YG Entertainment Inc. (KOSDAQ:122870) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for YG Entertainment

What Is YG Entertainment's Debt?

You can click the graphic below for the historical numbers, but it shows that YG Entertainment had ₩18.2b of debt in September 2020, down from ₩84.3b, one year before. However, it does have ₩117.1b in cash offsetting this, leading to net cash of ₩98.9b.

How Strong Is YG Entertainment's Balance Sheet?

According to the last reported balance sheet, YG Entertainment had liabilities of ₩91.5b due within 12 months, and liabilities of ₩21.9b due beyond 12 months. On the other hand, it had cash of ₩117.1b and ₩33.9b worth of receivables due within a year. So it can boast ₩37.5b more liquid assets than total liabilities.

This short term liquidity is a sign that YG Entertainment could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that YG Entertainment has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for YG Entertainment if management cannot prevent a repeat of the 89% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if YG Entertainment can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While YG Entertainment 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. Over the last three years, YG Entertainment saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that YG Entertainment has net cash of ₩98.9b, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about YG Entertainment's balance sheet. While YG Entertainment didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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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