We Think Microfriend (KOSDAQ:147760) Can Stay On Top Of Its Debt

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.' 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 can see that Microfriend Inc. (KOSDAQ:147760) does use debt in its business. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Microfriend

What Is Microfriend's Net Debt?

The chart below, which you can click on for greater detail, shows that Microfriend had ₩6.69b in debt in September 2020; about the same as the year before. However, it does have ₩16.6b in cash offsetting this, leading to net cash of ₩9.88b.

A Look At Microfriend's Liabilities

We can see from the most recent balance sheet that Microfriend had liabilities of ₩13.7b falling due within a year, and liabilities of ₩5.88b due beyond that. Offsetting these obligations, it had cash of ₩16.6b as well as receivables valued at ₩1.28b due within 12 months. So its liabilities total ₩1.69b more than the combination of its cash and short-term receivables.

Of course, Microfriend has a market capitalization of ₩69.4b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Microfriend also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Microfriend made a loss at the EBIT level, last year, it was also good to see that it generated ₩520m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Microfriend 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.

Finally, while the tax-man may adore accounting profits, lenders only accept 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. Over the last year, Microfriend actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Microfriend has ₩9.88b in net cash. The cherry on top was that in converted 1,051% of that EBIT to free cash flow, bringing in ₩5.5b. 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 instance, we've identified 2 warning signs for Microfriend (1 can't be ignored) 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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This article by Simply Wall St is general in nature. 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.
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