Tamul Multimedia (KOSDAQ:093640) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Tamul Multimedia Co., Ltd (KOSDAQ:093640) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Tamul Multimedia

What Is Tamul Multimedia's Net Debt?

The image below, which you can click on for greater detail, shows that Tamul Multimedia had debt of ₩7.33b at the end of September 2020, a reduction from ₩8.49b over a year. But it also has ₩10.6b in cash to offset that, meaning it has ₩3.23b net cash.

How Healthy Is Tamul Multimedia's Balance Sheet?

The latest balance sheet data shows that Tamul Multimedia had liabilities of ₩8.96b due within a year, and liabilities of ₩909.3m falling due after that. Offsetting these obligations, it had cash of ₩10.6b as well as receivables valued at ₩2.89b due within 12 months. So it actually has ₩3.58b more liquid assets than total liabilities.

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

Unfortunately, Tamul Multimedia's EBIT flopped 18% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tamul Multimedia will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Tamul Multimedia 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 two years, Tamul Multimedia actually produced more free cash flow than EBIT. 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 Tamul Multimedia has ₩3.23b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 426% of that EBIT to free cash flow, bringing in -₩1.5b. So we are not troubled with Tamul Multimedia's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Tamul Multimedia is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...

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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