Song Shang ElectronicsLtd (GTSM:6156) Could Easily Take On More Debt

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.' 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. Importantly, Song Shang Electronics Co.,Ltd. (GTSM:6156) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Song Shang ElectronicsLtd

What Is Song Shang ElectronicsLtd's Net Debt?

As you can see below, Song Shang ElectronicsLtd had NT$607.8m of debt at December 2020, down from NT$634.0m a year prior. But it also has NT$1.25b in cash to offset that, meaning it has NT$639.4m net cash.

How Strong Is Song Shang ElectronicsLtd's Balance Sheet?

According to the last reported balance sheet, Song Shang ElectronicsLtd had liabilities of NT$1.93b due within 12 months, and liabilities of NT$285.0m due beyond 12 months. On the other hand, it had cash of NT$1.25b and NT$1.49b worth of receivables due within a year. So it can boast NT$518.0m more liquid assets than total liabilities.

This surplus suggests that Song Shang ElectronicsLtd is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Song Shang ElectronicsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Song Shang ElectronicsLtd has boosted its EBIT by 89%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Song Shang ElectronicsLtd'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. Song Shang ElectronicsLtd 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, Song Shang ElectronicsLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Song Shang ElectronicsLtd has NT$639.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$274m, being 206% of its EBIT. The bottom line is that we do not find Song Shang ElectronicsLtd's debt levels at all concerning. 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. We've identified 3 warning signs with Song Shang ElectronicsLtd (at least 1 which is a bit concerning) , 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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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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