Here's Why Choong Ang Vaccine Laboratory (KOSDAQ:072020) Can Manage Its Debt Responsibly

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. Importantly, Choong Ang Vaccine Laboratory Co., Ltd. (KOSDAQ:072020) does carry debt. But should shareholders be worried about its use of debt?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Choong Ang Vaccine Laboratory

What Is Choong Ang Vaccine Laboratory's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Choong Ang Vaccine Laboratory had ₩10.1b of debt, an increase on ₩4.05b, over one year. But on the other hand it also has ₩28.0b in cash, leading to a ₩18.0b net cash position.

A Look At Choong Ang Vaccine Laboratory's Liabilities

Zooming in on the latest balance sheet data, we can see that Choong Ang Vaccine Laboratory had liabilities of ₩11.5b due within 12 months and liabilities of ₩5.92b due beyond that. Offsetting these obligations, it had cash of ₩28.0b as well as receivables valued at ₩2.97b due within 12 months. So it can boast ₩13.6b more liquid assets than total liabilities.

This surplus suggests that Choong Ang Vaccine Laboratory has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Choong Ang Vaccine Laboratory has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Choong Ang Vaccine Laboratory grew its EBIT by 104% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Choong Ang Vaccine Laboratory'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Choong Ang Vaccine Laboratory 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 last three years, Choong Ang Vaccine Laboratory recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Choong Ang Vaccine Laboratory has net cash of ₩18.0b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 104% over the last year. So is Choong Ang Vaccine Laboratory's debt a risk? It doesn't seem so to us. 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 instance, we've identified 1 warning sign for Choong Ang Vaccine Laboratory that you should be aware of.

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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