Is Perfect World (SZSE:002624) Using Debt Sensibly?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Perfect World Co., Ltd. (SZSE:002624) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Perfect World

How Much Debt Does Perfect World Carry?

As you can see below, at the end of June 2024, Perfect World had CN¥520.3m of debt, up from CN¥401.7m a year ago. Click the image for more detail. But it also has CN¥3.66b in cash to offset that, meaning it has CN¥3.14b net cash.

A Look At Perfect World's Liabilities

The latest balance sheet data shows that Perfect World had liabilities of CN¥3.91b due within a year, and liabilities of CN¥838.0m falling due after that. Offsetting this, it had CN¥3.66b in cash and CN¥914.3m in receivables that were due within 12 months. So its liabilities total CN¥172.2m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Perfect World's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥18.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Perfect World boasts net cash, so it's fair to say it does not have a heavy debt load! 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Perfect World had a loss before interest and tax, and actually shrunk its revenue by 26%, to CN¥6.1b. 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 the fact is that over the last twelve months Perfect World lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥188m and booked a CN¥65m accounting loss. Given it only has net cash of CN¥3.14b, 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. Case in point: We've spotted 1 warning sign for Perfect World you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.