These 4 Measures Indicate That Silicon Power Computer & Communications (GTSM:4973) Is Using Debt Reasonably Well

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Silicon Power Computer & Communications Inc. (GTSM:4973) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Silicon Power Computer & Communications

What Is Silicon Power Computer & Communications's Debt?

The image below, which you can click on for greater detail, shows that Silicon Power Computer & Communications had debt of NT$210.0m at the end of December 2020, a reduction from NT$240.0m over a year. However, its balance sheet shows it holds NT$529.2m in cash, so it actually has NT$319.2m net cash.

A Look At Silicon Power Computer & Communications' Liabilities

The latest balance sheet data shows that Silicon Power Computer & Communications had liabilities of NT$709.1m due within a year, and liabilities of NT$12.4m falling due after that. Offsetting this, it had NT$529.2m in cash and NT$471.8m in receivables that were due within 12 months. So it actually has NT$279.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Silicon Power Computer & Communications could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Silicon Power Computer & Communications has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Silicon Power Computer & Communications's load is not too heavy, because its EBIT was down 53% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is Silicon Power Computer & Communications'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Silicon Power Computer & Communications 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. Over the last three years, Silicon Power Computer & Communications actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case Silicon Power Computer & Communications has NT$319.2m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 597% of that EBIT to free cash flow, bringing in NT$282m. So we are not troubled with Silicon Power Computer & Communications's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with Silicon Power Computer & Communications (at least 1 which is significant) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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