Does Ability Enterprise (TWSE:2374) Have A 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.' 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. As with many other companies Ability Enterprise Co., Ltd. (TWSE:2374) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Ability Enterprise

How Much Debt Does Ability Enterprise Carry?

As you can see below, Ability Enterprise had NT$342.9m of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds NT$2.40b in cash, so it actually has NT$2.06b net cash.

How Healthy Is Ability Enterprise's Balance Sheet?

We can see from the most recent balance sheet that Ability Enterprise had liabilities of NT$2.50b falling due within a year, and liabilities of NT$68.7m due beyond that. Offsetting these obligations, it had cash of NT$2.40b as well as receivables valued at NT$1.04b due within 12 months. So it can boast NT$877.2m more liquid assets than total liabilities.

This surplus suggests that Ability Enterprise has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Ability Enterprise has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Ability Enterprise grew its EBIT by 1,236% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Ability Enterprise's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Ability Enterprise 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. Happily for any shareholders, Ability Enterprise actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Ability Enterprise has NT$2.06b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$97m, being 185% of its EBIT. So is Ability Enterprise's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Ability Enterprise you should be aware of.

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.