VATS Liquor Chain Store Management (SZSE:300755) Seems To Use Debt Quite Sensibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that VATS Liquor Chain Store Management Joint Stock Co., Ltd. (SZSE:300755) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for VATS Liquor Chain Store Management

What Is VATS Liquor Chain Store Management's Debt?

You can click the graphic below for the historical numbers, but it shows that VATS Liquor Chain Store Management had CN¥1.22b of debt in March 2024, down from CN¥1.33b, one year before. But on the other hand it also has CN¥1.77b in cash, leading to a CN¥558.2m net cash position.

How Strong Is VATS Liquor Chain Store Management's Balance Sheet?

We can see from the most recent balance sheet that VATS Liquor Chain Store Management had liabilities of CN¥3.47b falling due within a year, and liabilities of CN¥61.6m due beyond that. Offsetting these obligations, it had cash of CN¥1.77b as well as receivables valued at CN¥321.2m due within 12 months. So it has liabilities totalling CN¥1.43b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since VATS Liquor Chain Store Management has a market capitalization of CN¥6.21b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, VATS Liquor Chain Store Management boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that VATS Liquor Chain Store Management grew its EBIT by 11% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if VATS Liquor Chain Store Management can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. VATS Liquor Chain Store Management 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, VATS Liquor Chain Store Management created free cash flow amounting to 18% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

Although VATS Liquor Chain Store Management's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥558.2m. And it also grew its EBIT by 11% over the last year. So we are not troubled with VATS Liquor Chain Store Management's debt use. 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. Be aware that VATS Liquor Chain Store Management is showing 2 warning signs in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.

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