Warren Buffett said: “Volatility is far from synonymous with risk. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that Zhaobangji Properties Holdings Limited (HKG:1660) has a debt on its balance sheet. But the real question is whether this debt makes the business risky.

When is debt a problem?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

Check out our latest analysis for Zhaobangji Properties Holdings

How much debt does Zhaobangji Properties Holdings have?

You can click on the graph below for historical numbers, but it shows that Zhaobangji Properties Holdings had HK$14.0 million in debt in September 2021, up from HK$19.9 million a year earlier. However, his balance sheet shows that he holds HK$217.3 million in cash, so he actually has HK$203.3 million in cash.

How healthy is Zhaobangji Properties Holdings’ balance sheet?

Zooming in on the latest balance sheet data, we can see that Zhaobangji Properties Holdings had liabilities of HK$87.6 million due within 12 months and liabilities of HK$33.4 million due beyond. In return, he had HK$217.3 million in cash and HK$80.4 million in debt due within 12 months. It can therefore boast that it has HK$176.7 million more in cash than total Passives.

This short-term liquidity is a sign that Zhaobangji Properties Holdings could probably service its debt easily, as its balance sheet is far from stretched. Put simply, the fact that Zhaobangji Properties Holdings has more cash than debt is arguably a good indication that it can safely manage its debt.

On the other hand, Zhaobangji Properties Holdings’ EBIT fell 11% over the past year. We believe that this type of performance, if repeated frequently, could well spell trouble for the stock. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since Zhaobangji Properties Holdings will need revenue to repay this debt. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. Zhaobangji Properties Holdings may have net cash on the balance sheet, but it is always interesting to see how well the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. Over the past three years, Zhaobangji Properties Holdings’ free cash flow has been 25% of its EBIT, less than expected. It’s not great when it comes to paying off debt.

Abstract

While we sympathize with investors who find debt a concern, you should keep in mind that Zhaobangji Properties Holdings has net cash of HK$203.3 million, as well as more liquid assets than liabilities. . We are therefore not concerned about the use of Zhaobangji Properties Holdings’ debt. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Zhaobangji Properties Holdings (1 of which is a little worrying!) that you should know about.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.