Korea Information & Communications (KOSDAQ:025770) Has A Pretty Healthy Balance Sheet

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Korea Information & Communications Co., Ltd. (KOSDAQ:025770) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Korea Information & Communications

What Is Korea Information & Communications's Net Debt?

The image below, which you can click on for greater detail, shows that Korea Information & Communications had debt of ₩3.00b at the end of June 2020, a reduction from ₩5.00b over a year. But it also has ₩77.5b in cash to offset that, meaning it has ₩74.5b net cash.

A Look At Korea Information & Communications's Liabilities

The latest balance sheet data shows that Korea Information & Communications had liabilities of ₩99.9b due within a year, and liabilities of ₩14.5b falling due after that. Offsetting this, it had ₩77.5b in cash and ₩120.8b in receivables that were due within 12 months. So it actually has ₩83.9b more liquid assets than total liabilities.

This surplus suggests that Korea Information & Communications is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Korea Information & Communications has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Korea Information & Communications has seen its EBIT plunge 11% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Korea Information & Communications will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Korea Information & Communications 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. In the last three years, Korea Information & Communications's free cash flow amounted to 34% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Korea Information & Communications has net cash of ₩74.5b, as well as more liquid assets than liabilities. So we are not troubled with Korea Information & Communications'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. To that end, you should be aware of the 2 warning signs we've spotted with Korea Information & Communications .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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