Does Dadi Early-Childhood Education Group (GTSM:8437) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that Dadi Early-Childhood Education Group Limited (GTSM:8437) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. 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 Dadi Early-Childhood Education Group

What Is Dadi Early-Childhood Education Group's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Dadi Early-Childhood Education Group had debt of NT$957.4m, up from NT$770.3m in one year. But on the other hand it also has NT$1.52b in cash, leading to a NT$560.9m net cash position.

How Strong Is Dadi Early-Childhood Education Group's Balance Sheet?

According to the last reported balance sheet, Dadi Early-Childhood Education Group had liabilities of NT$1.15b due within 12 months, and liabilities of NT$105.3m due beyond 12 months. On the other hand, it had cash of NT$1.52b and NT$554.0m worth of receivables due within a year. So it actually has NT$812.4m more liquid assets than total liabilities.

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

In fact Dadi Early-Childhood Education Group's saving grace is its low debt levels, because its EBIT has tanked 65% in the last twelve months. 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 ultimately the future profitability of the business will decide if Dadi Early-Childhood Education Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Dadi Early-Childhood Education Group 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. In the last three years, Dadi Early-Childhood Education Group's free cash flow amounted to 47% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Dadi Early-Childhood Education Group has NT$560.9m in net cash and a decent-looking balance sheet. So we don't have any problem with Dadi Early-Childhood Education Group's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Dadi Early-Childhood Education Group has 1 warning sign we think 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. 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.
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