Is Kidswant Children ProductsLtd (SZSE:301078) A Risky Investment?

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 note that Kidswant Children Products Co.,Ltd. (SZSE:301078) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Kidswant Children ProductsLtd

How Much Debt Does Kidswant Children ProductsLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Kidswant Children ProductsLtd had CN¥1.97b of debt, an increase on CN¥910.9m, over one year. But on the other hand it also has CN¥3.17b in cash, leading to a CN¥1.20b net cash position.

How Healthy Is Kidswant Children ProductsLtd's Balance Sheet?

We can see from the most recent balance sheet that Kidswant Children ProductsLtd had liabilities of CN¥3.25b falling due within a year, and liabilities of CN¥3.22b due beyond that. Offsetting these obligations, it had cash of CN¥3.17b as well as receivables valued at CN¥296.3m due within 12 months. So its liabilities total CN¥3.00b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Kidswant Children ProductsLtd is worth CN¥8.21b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Kidswant Children ProductsLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Kidswant Children ProductsLtd's EBIT fell a jaw-dropping 23% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Kidswant Children ProductsLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Kidswant Children ProductsLtd 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. Happily for any shareholders, Kidswant Children ProductsLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While Kidswant Children ProductsLtd does have more liabilities than liquid assets, it also has net cash of CN¥1.20b. And it impressed us with free cash flow of CN¥44m, being 134% of its EBIT. So we don't have any problem with Kidswant Children ProductsLtd's use of debt. 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. To that end, you should be aware of the 1 warning sign we've spotted with Kidswant Children ProductsLtd .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.