These 4 Measures Indicate That Gaonchips (KOSDAQ:399720) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Gaonchips Co., Ltd. (KOSDAQ:399720) does carry debt. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

View our latest analysis for Gaonchips

What Is Gaonchips's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Gaonchips had ₩4.03b of debt, an increase on ₩1.93b, over one year. But it also has ₩31.2b in cash to offset that, meaning it has ₩27.2b net cash.

How Healthy Is Gaonchips' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gaonchips had liabilities of ₩19.2b due within 12 months and liabilities of ₩8.61b due beyond that. Offsetting these obligations, it had cash of ₩31.2b as well as receivables valued at ₩10.7b due within 12 months. So it actually has ₩14.2b more liquid assets than total liabilities.

This state of affairs indicates that Gaonchips' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₩1.30t company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Gaonchips has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Gaonchips has increased its EBIT by 2.8% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Gaonchips's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Gaonchips 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, Gaonchips 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 it is always sensible to investigate a company's debt, in this case Gaonchips has ₩27.2b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 2.8% over the last year. So we don't have any problem with Gaonchips's use of debt. 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. For instance, we've identified 3 warning signs for Gaonchips (2 make us uncomfortable) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.