We Think Philoptics (KOSDAQ:161580) 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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Philoptics Co., Ltd. (KOSDAQ:161580) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Philoptics

What Is Philoptics's Debt?

The image below, which you can click on for greater detail, shows that Philoptics had debt of ₩66.3b at the end of December 2023, a reduction from ₩120.4b over a year. But on the other hand it also has ₩149.2b in cash, leading to a ₩82.9b net cash position.

How Strong Is Philoptics' Balance Sheet?

We can see from the most recent balance sheet that Philoptics had liabilities of ₩207.4b falling due within a year, and liabilities of ₩11.6b due beyond that. Offsetting these obligations, it had cash of ₩149.2b as well as receivables valued at ₩12.9b due within 12 months. So its liabilities total ₩56.9b more than the combination of its cash and short-term receivables.

Given Philoptics has a market capitalization of ₩696.2b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Philoptics also has more cash than debt, so we're pretty confident it can manage its debt safely.

Shareholders should be aware that Philoptics's EBIT was down 42% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Philoptics 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Philoptics has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Philoptics actually produced more free cash flow than EBIT over the last two years. 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 look at a company's total liabilities, it is very reassuring that Philoptics has ₩82.9b in net cash. The cherry on top was that in converted 149% of that EBIT to free cash flow, bringing in ₩79b. So we don't have any problem with Philoptics's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Philoptics (at least 1 which is significant) , and understanding them should be part of your investment process.

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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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.