Does Gamania Digital Entertainment (GTSM:6180) 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 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. Importantly, Gamania Digital Entertainment Co., Ltd. (GTSM:6180) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Gamania Digital Entertainment

What Is Gamania Digital Entertainment's Net Debt?

As you can see below, Gamania Digital Entertainment had NT$466.1m of debt at December 2020, down from NT$1.15b a year prior. However, it does have NT$2.44b in cash offsetting this, leading to net cash of NT$1.97b.

How Strong Is Gamania Digital Entertainment's Balance Sheet?

According to the last reported balance sheet, Gamania Digital Entertainment had liabilities of NT$3.58b due within 12 months, and liabilities of NT$213.6m due beyond 12 months. Offsetting this, it had NT$2.44b in cash and NT$1.28b in receivables that were due within 12 months. So its liabilities total NT$81.3m more than the combination of its cash and short-term receivables.

Having regard to Gamania Digital Entertainment's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the NT$11.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Gamania Digital Entertainment also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Gamania Digital Entertainment saw its EBIT decline by 9.7% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Gamania Digital Entertainment can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Gamania Digital Entertainment 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. Over the last three years, Gamania Digital Entertainment recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Gamania Digital Entertainment has NT$1.97b in net cash. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in NT$1.2b. So is Gamania Digital Entertainment'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. For example, we've discovered 1 warning sign for Gamania Digital Entertainment 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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