These 4 Measures Indicate That Elite Material (TWSE:2383) 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 can see that Elite Material Co., Ltd. (TWSE:2383) does use debt in its business. 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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Elite Material

What Is Elite Material's Debt?

The image below, which you can click on for greater detail, shows that Elite Material had debt of NT$10.6b at the end of March 2024, a reduction from NT$12.4b over a year. However, its balance sheet shows it holds NT$12.6b in cash, so it actually has NT$2.00b net cash.

A Look At Elite Material's Liabilities

We can see from the most recent balance sheet that Elite Material had liabilities of NT$29.8b falling due within a year, and liabilities of NT$3.48b due beyond that. Offsetting this, it had NT$12.6b in cash and NT$18.4b in receivables that were due within 12 months. So its liabilities total NT$2.31b more than the combination of its cash and short-term receivables.

This state of affairs indicates that Elite Material's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the NT$148.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Elite Material also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Elite Material has boosted its EBIT by 71%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Elite Material's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Elite Material 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. In the last three years, Elite Material created free cash flow amounting to 8.2% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Elite Material has NT$2.00b in net cash. And we liked the look of last year's 71% year-on-year EBIT growth. So we don't think Elite Material's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Elite Material (of which 1 is significant!) 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.