Is Perfect World (SZSE:002624) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Perfect World Co., Ltd. (SZSE:002624) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Perfect World

How Much Debt Does Perfect World Carry?

As you can see below, Perfect World had CN¥200.0m of debt at September 2024, down from CN¥500.5m a year prior. But on the other hand it also has CN¥2.82b in cash, leading to a CN¥2.62b net cash position.

A Look At Perfect World's Liabilities

According to the last reported balance sheet, Perfect World had liabilities of CN¥3.49b due within 12 months, and liabilities of CN¥764.0m due beyond 12 months. On the other hand, it had cash of CN¥2.82b and CN¥797.7m worth of receivables due within a year. So it has liabilities totalling CN¥633.1m more than its cash and near-term receivables, combined.

Of course, Perfect World has a market capitalization of CN¥22.5b, so these liabilities are probably manageable. 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, Perfect World also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Perfect World 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.

Over 12 months, Perfect World made a loss at the EBIT level, and saw its revenue drop to CN¥5.7b, which is a fall of 30%. That makes us nervous, to say the least.

So How Risky Is Perfect World?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Perfect World had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of CN¥375m and booked a CN¥512m accounting loss. Given it only has net cash of CN¥2.62b, the company may need to raise more capital if it doesn't reach break-even soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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. We've identified 1 warning sign with Perfect World , and understanding them should be part of your investment process.

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.