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.' 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. As with many other companies Shenzhen Best of Best Holdings Co.,Ltd. (SZSE:001298) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is Shenzhen Best of Best HoldingsLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Shenzhen Best of Best HoldingsLtd had CN¥704.3m of debt, an increase on CN¥668.6m, over one year. But it also has CN¥794.4m in cash to offset that, meaning it has CN¥90.1m net cash.

How Healthy Is Shenzhen Best of Best HoldingsLtd's Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Best of Best HoldingsLtd had liabilities of CN¥1.12b falling due within a year, and liabilities of CN¥3.36m due beyond that. On the other hand, it had cash of CN¥794.4m and CN¥1.11b worth of receivables due within a year. So it actually has CN¥783.3m more liquid assets than total liabilities.

This surplus suggests that Shenzhen Best of Best HoldingsLtd is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Shenzhen Best of Best HoldingsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Shareholders should be aware that Shenzhen Best of Best HoldingsLtd's EBIT was down 37% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shenzhen Best of Best HoldingsLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shenzhen Best of Best HoldingsLtd 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. Over the last three years, Shenzhen Best of Best HoldingsLtd recorded negative free cash flow, in total. 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 it is always sensible to investigate a company's debt, in this case Shenzhen Best of Best HoldingsLtd has CN¥90.1m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Shenzhen Best of Best HoldingsLtd's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Shenzhen Best of Best HoldingsLtd is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com