Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 VATS Liquor Chain Store Management Joint Stock Co., Ltd. (SZSE:300755) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does VATS Liquor Chain Store Management Carry?
As you can see below, at the end of September 2023, VATS Liquor Chain Store Management had CN¥1.24b of debt, up from CN¥774.8m a year ago. Click the image for more detail. However, it does have CN¥2.03b in cash offsetting this, leading to net cash of CN¥785.0m.
A Look At VATS Liquor Chain Store Management's Liabilities
The latest balance sheet data shows that VATS Liquor Chain Store Management had liabilities of CN¥3.70b due within a year, and liabilities of CN¥63.1m falling due after that. On the other hand, it had cash of CN¥2.03b and CN¥486.3m worth of receivables due within a year. So its liabilities total CN¥1.25b more than the combination of its cash and short-term receivables.
Given VATS Liquor Chain Store Management has a market capitalization of CN¥7.16b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, VATS Liquor Chain Store Management boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for VATS Liquor Chain Store Management if management cannot prevent a repeat of the 49% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 VATS Liquor Chain Store Management'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While VATS Liquor Chain Store Management 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. Considering the last three years, VATS Liquor Chain Store Management actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
Summing Up
While VATS Liquor Chain Store Management does have more liabilities than liquid assets, it also has net cash of CN¥785.0m. So while VATS Liquor Chain Store Management does not have a great balance sheet, it's certainly not too bad. 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. Be aware that VATS Liquor Chain Store Management is showing 2 warning signs in our investment analysis , 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.