Is Three Squirrels (SZSE:300783) 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. As with many other companies Three Squirrels Inc. (SZSE:300783) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Three Squirrels

How Much Debt Does Three Squirrels Carry?

You can click the graphic below for the historical numbers, but it shows that Three Squirrels had CN¥312.1m of debt in September 2024, down from CN¥512.2m, one year before. However, it does have CN¥414.1m in cash offsetting this, leading to net cash of CN¥102.1m.

A Look At Three Squirrels' Liabilities

According to the last reported balance sheet, Three Squirrels had liabilities of CN¥1.53b due within 12 months, and liabilities of CN¥257.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥414.1m as well as receivables valued at CN¥469.5m due within 12 months. So it has liabilities totalling CN¥901.8m more than its cash and near-term receivables, combined.

Of course, Three Squirrels has a market capitalization of CN¥11.5b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Three Squirrels boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Three Squirrels grew its EBIT by 110% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Three Squirrels 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Three Squirrels 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. Over the last two years, Three Squirrels recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Three Squirrels has CN¥102.1m in net cash. And it impressed us with its EBIT growth of 110% over the last year. So we don't have any problem with Three Squirrels's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Three Squirrels has 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.