Here's Why Firich Enterprises (GTSM:8076) Can Manage Its Debt Responsibly

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.' 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. As with many other companies Firich Enterprises Co., Ltd. (GTSM:8076) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

View our latest analysis for Firich Enterprises

What Is Firich Enterprises's Debt?

You can click the graphic below for the historical numbers, but it shows that Firich Enterprises had NT$1.66b of debt in September 2020, down from NT$1.87b, one year before. However, its balance sheet shows it holds NT$1.67b in cash, so it actually has NT$2.91m net cash.

How Healthy Is Firich Enterprises's Balance Sheet?

According to the last reported balance sheet, Firich Enterprises had liabilities of NT$2.55b due within 12 months, and liabilities of NT$27.6m due beyond 12 months. On the other hand, it had cash of NT$1.67b and NT$677.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$234.2m.

Of course, Firich Enterprises has a market capitalization of NT$7.55b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Firich Enterprises also has more cash than debt, so we're pretty confident it can manage its debt safely.

Shareholders should be aware that Firich Enterprises's EBIT was down 87% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Firich Enterprises'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 company can only pay off debt with cold hard cash, not accounting profits. While Firich Enterprises 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, Firich Enterprises 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

We could understand if investors are concerned about Firich Enterprises's liabilities, but we can be reassured by the fact it has has net cash of NT$2.91m. And it impressed us with free cash flow of NT$186m, being 128% of its EBIT. So we are not troubled with Firich Enterprises'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. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for Firich Enterprises 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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