The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, Emdoor Information CO.,LTD. (SZSE:001314) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
What Is Emdoor InformationLTD's Debt?
The image below, which you can click on for greater detail, shows that Emdoor InformationLTD had debt of CN¥94.8m at the end of March 2024, a reduction from CN¥265.3m over a year. But it also has CN¥1.26b in cash to offset that, meaning it has CN¥1.17b net cash.
A Look At Emdoor InformationLTD's Liabilities
Zooming in on the latest balance sheet data, we can see that Emdoor InformationLTD had liabilities of CN¥889.7m due within 12 months and liabilities of CN¥58.8m due beyond that. Offsetting this, it had CN¥1.26b in cash and CN¥259.6m in receivables that were due within 12 months. So it actually has CN¥573.4m more liquid assets than total liabilities.
This short term liquidity is a sign that Emdoor InformationLTD could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Emdoor InformationLTD has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that Emdoor InformationLTD's load is not too heavy, because its EBIT was down 81% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Emdoor InformationLTD's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Emdoor InformationLTD 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. Considering the last three years, Emdoor InformationLTD actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Emdoor InformationLTD has net cash of CN¥1.17b, as well as more liquid assets than liabilities. So while Emdoor InformationLTD does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Emdoor InformationLTD (including 1 which is a bit unpleasant) .
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. 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.
