Is Qingdao KutesmartLtd (SZSE:300840) Using Too Much Debt?

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 can see that Qingdao Kutesmart Co.,Ltd. (SZSE:300840) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Qingdao KutesmartLtd

How Much Debt Does Qingdao KutesmartLtd Carry?

The image below, which you can click on for greater detail, shows that Qingdao KutesmartLtd had debt of CN¥100.0m at the end of September 2024, a reduction from CN¥280.0m over a year. However, it does have CN¥470.9m in cash offsetting this, leading to net cash of CN¥370.9m.

How Strong Is Qingdao KutesmartLtd's Balance Sheet?

According to the last reported balance sheet, Qingdao KutesmartLtd had liabilities of CN¥320.8m due within 12 months, and liabilities of CN¥70.4m due beyond 12 months. On the other hand, it had cash of CN¥470.9m and CN¥124.9m worth of receivables due within a year. So it actually has CN¥204.7m more liquid assets than total liabilities.

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

Another good sign is that Qingdao KutesmartLtd has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Qingdao KutesmartLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Qingdao KutesmartLtd 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. In the last three years, Qingdao KutesmartLtd's free cash flow amounted to 37% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Qingdao KutesmartLtd has net cash of CN¥370.9m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 24% over the last year. So we don't think Qingdao KutesmartLtd's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Qingdao KutesmartLtd you should know about.

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.