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.' 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 Huafa Property Services Group Company Limited (HKG:982) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Huafa Property Services Group Carry?

The image below, which you can click on for greater detail, shows that Huafa Property Services Group had debt of CN¥175.6m at the end of December 2023, a reduction from CN¥381.4m over a year. However, its balance sheet shows it holds CN¥408.6m in cash, so it actually has CN¥233.0m net cash.

How Healthy Is Huafa Property Services Group's Balance Sheet?

We can see from the most recent balance sheet that Huafa Property Services Group had liabilities of CN¥793.3m falling due within a year, and liabilities of CN¥5.90m due beyond that. On the other hand, it had cash of CN¥408.6m and CN¥510.1m worth of receivables due within a year. So it actually has CN¥119.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Huafa Property Services Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Huafa Property Services Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Huafa Property Services Group has boosted its EBIT by 35%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is Huafa Property Services Group'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 company can only pay off debt with cold hard cash, not accounting profits. Huafa Property Services Group 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. Over the most recent three years, Huafa Property Services Group recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Huafa Property Services Group has net cash of CN¥233.0m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 35% over the last year. So we don't think Huafa Property Services Group's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Huafa Property Services Group's earnings per share history for free.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.