These 4 Measures Indicate That Digital Power CommunicationsLtd (KRX:026890) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Digital Power Communications Co.,Ltd. (KRX:026890) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Digital Power CommunicationsLtd

What Is Digital Power CommunicationsLtd's Debt?

The chart below, which you can click on for greater detail, shows that Digital Power CommunicationsLtd had ₩23.1b in debt in September 2020; about the same as the year before. However, its balance sheet shows it holds ₩58.4b in cash, so it actually has ₩35.3b net cash.

A Look At Digital Power CommunicationsLtd's Liabilities

According to the last reported balance sheet, Digital Power CommunicationsLtd had liabilities of ₩61.2b due within 12 months, and liabilities of ₩3.87b due beyond 12 months. Offsetting this, it had ₩58.4b in cash and ₩59.6b in receivables that were due within 12 months. So it can boast ₩52.9b more liquid assets than total liabilities.

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

On top of that, Digital Power CommunicationsLtd grew its EBIT by 60% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Digital Power CommunicationsLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Digital Power CommunicationsLtd 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, Digital Power CommunicationsLtd created free cash flow amounting to 17% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Digital Power CommunicationsLtd has net cash of ₩35.3b, as well as more liquid assets than liabilities. And we liked the look of last year's 60% year-on-year EBIT growth. So we don't think Digital Power CommunicationsLtd's use of debt is risky. 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. Case in point: We've spotted 2 warning signs for Digital Power CommunicationsLtd you should be aware of, and 1 of them is significant.

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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