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.' 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. We can see that Changhua Holding Group Co., Ltd. (SHSE:605018) does use debt in its business. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Changhua Holding Group's Debt?

As you can see below, Changhua Holding Group had CN¥72.1m of debt at September 2024, down from CN¥160.1m a year prior. However, its balance sheet shows it holds CN¥412.5m in cash, so it actually has CN¥340.4m net cash.

How Strong Is Changhua Holding Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Changhua Holding Group had liabilities of CN¥425.3m due within 12 months and liabilities of CN¥62.4m due beyond that. On the other hand, it had cash of CN¥412.5m and CN¥332.9m worth of receivables due within a year. So it can boast CN¥257.6m more liquid assets than total liabilities.

This surplus suggests that Changhua Holding Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Changhua Holding Group has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Changhua Holding Group has boosted its EBIT by 82%, 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 Changhua Holding Group's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Changhua Holding Group 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, Changhua Holding Group saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Changhua Holding Group has CN¥340.4m in net cash and a decent-looking balance sheet. And we liked the look of last year's 82% year-on-year EBIT growth. So we are not troubled with Changhua Holding Group's debt use. 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. For example, we've discovered 2 warning signs for Changhua Holding Group (1 is potentially serious!) that you should be aware of before investing here.

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.

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