Avaco (KOSDAQ:083930) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Avaco Co., Ltd. (KOSDAQ:083930) makes use of debt. But the real question is whether this debt is making the company risky.

We've discovered 2 warning signs about Avaco. View them for free.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

What Is Avaco's Net Debt?

As you can see below, at the end of December 2024, Avaco had ₩16.2b of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds ₩35.6b in cash, so it actually has ₩19.4b net cash.

A Look At Avaco's Liabilities

According to the last reported balance sheet, Avaco had liabilities of ₩183.9b due within 12 months, and liabilities of ₩5.63b due beyond 12 months. Offsetting these obligations, it had cash of ₩35.6b as well as receivables valued at ₩114.5b due within 12 months. So its liabilities total ₩39.4b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Avaco has a market capitalization of ₩194.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Avaco also has more cash than debt, so we're pretty confident it can manage its debt safely.

View our latest analysis for Avaco

Even more impressive was the fact that Avaco grew its EBIT by 379% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Avaco 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. Avaco 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, Avaco saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While Avaco does have more liabilities than liquid assets, it also has net cash of ₩19.4b. And it impressed us with its EBIT growth of 379% over the last year. So we don't have any problem with Avaco's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Avaco you should be aware of, and 1 of them is a bit unpleasant.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.