The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Microfriend Inc. (KOSDAQ:147760) does carry debt. But the more important question is: how much risk is that debt creating?
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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Microfriend
What Is Microfriend's Debt?
As you can see below, Microfriend had ₩6.65b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has ₩17.7b in cash to offset that, meaning it has ₩11.0b net cash.
How Strong Is Microfriend's Balance Sheet?
We can see from the most recent balance sheet that Microfriend had liabilities of ₩14.0b falling due within a year, and liabilities of ₩4.34b due beyond that. Offsetting this, it had ₩17.7b in cash and ₩5.59b in receivables that were due within 12 months. So it can boast ₩4.93b more liquid assets than total liabilities.
This short term liquidity is a sign that Microfriend could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Microfriend boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Microfriend made a loss at the EBIT level, last year, it was also good to see that it generated ₩4.9b in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Microfriend'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. Microfriend 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. Happily for any shareholders, Microfriend 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 Microfriend has ₩11.0b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 169% of that EBIT to free cash flow, bringing in ₩8.3b. So is Microfriend'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 example Microfriend has 3 warning signs (and 1 which is potentially serious) we think you should know about.
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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About KOSDAQ:A147760
Protec Mems Technology
Engages in the production and sale of semiconductor inspection equipment in South Korea and internationally.
Mediocre balance sheet low.
