Here's Why Elcomtec (KOSDAQ:037950) Can Manage Its Debt Responsibly

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. Importantly, Elcomtec Co., Ltd (KOSDAQ:037950) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Elcomtec

What Is Elcomtec's Debt?

The image below, which you can click on for greater detail, shows that Elcomtec had debt of ₩3.20b at the end of September 2023, a reduction from ₩3.41b over a year. But on the other hand it also has ₩14.6b in cash, leading to a ₩11.4b net cash position.

How Healthy Is Elcomtec's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Elcomtec had liabilities of ₩5.10b due within 12 months and liabilities of ₩3.72b due beyond that. On the other hand, it had cash of ₩14.6b and ₩12.0b worth of receivables due within a year. So it actually has ₩17.8b more liquid assets than total liabilities.

This short term liquidity is a sign that Elcomtec could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Elcomtec boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Elcomtec if management cannot prevent a repeat of the 27% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Elcomtec 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Elcomtec 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, Elcomtec 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 we empathize with investors who find debt concerning, you should keep in mind that Elcomtec has net cash of ₩11.4b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₩6.2b, being 143% of its EBIT. So we don't have any problem with Elcomtec's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Elcomtec that you should be aware of before investing here.

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. 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.