Here's Why Suofeiya Home Collection (SZSE:002572) Can Manage Its Debt Responsibly

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 note that Suofeiya Home Collection Co., Ltd. (SZSE:002572) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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 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. 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.

Check out our latest analysis for Suofeiya Home Collection

What Is Suofeiya Home Collection's Net Debt?

As you can see below, at the end of March 2024, Suofeiya Home Collection had CN¥2.94b of debt, up from CN¥2.60b a year ago. Click the image for more detail. However, it does have CN¥2.99b in cash offsetting this, leading to net cash of CN¥52.8m.

How Strong Is Suofeiya Home Collection's Balance Sheet?

We can see from the most recent balance sheet that Suofeiya Home Collection had liabilities of CN¥4.92b falling due within a year, and liabilities of CN¥1.06b due beyond that. Offsetting this, it had CN¥2.99b in cash and CN¥1.38b in receivables that were due within 12 months. So its liabilities total CN¥1.61b more than the combination of its cash and short-term receivables.

Since publicly traded Suofeiya Home Collection shares are worth a total of CN¥18.5b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Suofeiya Home Collection also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Suofeiya Home Collection has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Suofeiya Home Collection can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Suofeiya Home Collection 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. In the last three years, Suofeiya Home Collection's free cash flow amounted to 38% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

We could understand if investors are concerned about Suofeiya Home Collection's liabilities, but we can be reassured by the fact it has has net cash of CN¥52.8m. And it impressed us with its EBIT growth of 28% over the last year. So is Suofeiya Home Collection's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Suofeiya Home Collection you should be aware of.

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.