Is Good Will Instrument (TPE:2423) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Good Will Instrument Co., Ltd. (TPE:2423) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Good Will Instrument

What Is Good Will Instrument's Debt?

As you can see below, at the end of December 2020, Good Will Instrument had NT$596.2m of debt, up from NT$112.3m a year ago. Click the image for more detail. But it also has NT$807.4m in cash to offset that, meaning it has NT$211.1m net cash.

How Strong Is Good Will Instrument's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Good Will Instrument had liabilities of NT$970.0m due within 12 months and liabilities of NT$391.7m due beyond that. Offsetting this, it had NT$807.4m in cash and NT$780.9m in receivables that were due within 12 months. So it actually has NT$226.6m more liquid assets than total liabilities.

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

It is just as well that Good Will Instrument's load is not too heavy, because its EBIT was down 26% 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 Good Will Instrument'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 Good Will Instrument 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, Good Will Instrument recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Good Will Instrument has NT$211.1m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in NT$451m. So we are not troubled with Good Will Instrument's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Good Will Instrument that you should be aware of.

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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