Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Huaxi Holdings Company Limited (HKG:1689) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Huaxi Holdings

How Much Debt Does Huaxi Holdings Carry?

As you can see below, at the end of December 2022, Huaxi Holdings had HK$22.4m of debt, up from none a year ago. Click the image for more detail. But it also has HK$99.4m in cash to offset that, meaning it has HK$77.0m net cash.

How Strong Is Huaxi Holdings' Balance Sheet?

According to the last reported balance sheet, Huaxi Holdings had liabilities of HK$208.5m due within 12 months, and liabilities of HK$7.47m due beyond 12 months. Offsetting this, it had HK$99.4m in cash and HK$267.6m in receivables that were due within 12 months. So it can boast HK$151.0m more liquid assets than total liabilities.

This luscious liquidity implies that Huaxi Holdings' balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Huaxi Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Huaxi Holdings will need earnings to service that debt. 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.

In the last year Huaxi Holdings had a loss before interest and tax, and actually shrunk its revenue by 52%, to HK$195m. That makes us nervous, to say the least.

So How Risky Is Huaxi Holdings?

Although Huaxi Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of HK$25m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. There's no doubt the next few years will be crucial to how the business matures. 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. For example Huaxi Holdings has 2 warning signs (and 1 which is concerning) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.