Is Skytech (TWSE:6937) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Skytech Inc. (TWSE:6937) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Skytech

What Is Skytech's Net Debt?

The image below, which you can click on for greater detail, shows that Skytech had debt of NT$225.7m at the end of June 2024, a reduction from NT$352.4m over a year. However, its balance sheet shows it holds NT$912.7m in cash, so it actually has NT$687.1m net cash.

A Look At Skytech's Liabilities

Zooming in on the latest balance sheet data, we can see that Skytech had liabilities of NT$670.5m due within 12 months and liabilities of NT$246.8m due beyond that. On the other hand, it had cash of NT$912.7m and NT$654.6m worth of receivables due within a year. So it can boast NT$650.0m more liquid assets than total liabilities.

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

Also good is that Skytech grew its EBIT at 19% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Skytech's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Skytech 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. Considering the last three years, Skytech actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case Skytech has NT$687.1m in net cash and a decent-looking balance sheet. And we liked the look of last year's 19% year-on-year EBIT growth. So we are not troubled with Skytech's debt use. 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. For example Skytech has 3 warning signs (and 1 which is a bit concerning) we think 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. 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.