Ample Electronic TechnologyLtd (GTSM:4760) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Ample Electronic Technology Co.,Ltd. (GTSM:4760) does use debt in its business. But the more important question is: how much risk is that debt creating?

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, 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 Ample Electronic TechnologyLtd

What Is Ample Electronic TechnologyLtd's Debt?

As you can see below, at the end of September 2020, Ample Electronic TechnologyLtd had NT$355.2m of debt, up from NT$231.9m a year ago. Click the image for more detail. However, it does have NT$107.8m in cash offsetting this, leading to net debt of about NT$247.4m.

A Look At Ample Electronic TechnologyLtd's Liabilities

We can see from the most recent balance sheet that Ample Electronic TechnologyLtd had liabilities of NT$362.4m falling due within a year, and liabilities of NT$141.6m due beyond that. Offsetting these obligations, it had cash of NT$107.8m as well as receivables valued at NT$434.0m due within 12 months. So it actually has NT$37.7m more liquid assets than total liabilities.

This state of affairs indicates that Ample Electronic TechnologyLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the NT$3.36b company is short on cash, but still worth keeping an eye on the balance sheet.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Ample Electronic TechnologyLtd's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its commanding EBIT of 27.3 times its interest expense, implies the debt load is as light as a peacock feather. Better yet, Ample Electronic TechnologyLtd grew its EBIT by 259% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Ample Electronic TechnologyLtd 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Ample Electronic TechnologyLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Ample Electronic TechnologyLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that Ample Electronic TechnologyLtd can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Ample Electronic TechnologyLtd (of which 2 shouldn't be ignored!) you should know about.

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. 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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