ChoA PharmaceuticalLtd (KOSDAQ:034940) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that ChoA Pharmaceutical Co.,Ltd (KOSDAQ:034940) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for ChoA PharmaceuticalLtd

What Is ChoA PharmaceuticalLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that ChoA PharmaceuticalLtd had ₩8.20b of debt in September 2020, down from ₩17.1b, one year before. However, its balance sheet shows it holds ₩10.6b in cash, so it actually has ₩2.37b net cash.

How Healthy Is ChoA PharmaceuticalLtd's Balance Sheet?

The latest balance sheet data shows that ChoA PharmaceuticalLtd had liabilities of ₩19.5b due within a year, and liabilities of ₩8.54b falling due after that. Offsetting this, it had ₩10.6b in cash and ₩27.2b in receivables that were due within 12 months. So it actually has ₩9.77b more liquid assets than total liabilities.

This short term liquidity is a sign that ChoA PharmaceuticalLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, ChoA PharmaceuticalLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

We also note that ChoA PharmaceuticalLtd improved its EBIT from a last year's loss to a positive ₩18m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since ChoA PharmaceuticalLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While ChoA PharmaceuticalLtd 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. Happily for any shareholders, ChoA PharmaceuticalLtd actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case ChoA PharmaceuticalLtd has ₩2.37b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 7,780% of that EBIT to free cash flow, bringing in ₩1.4b. So we are not troubled with ChoA PharmaceuticalLtd's debt use. 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. For example ChoA PharmaceuticalLtd has 2 warning signs (and 1 which is potentially serious) we think you should know about.

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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