Perfect World (SZSE:002624) Has A Pretty Healthy Balance Sheet

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Perfect World Co., Ltd. (SZSE:002624) does use debt in its business. 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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Perfect World

What Is Perfect World's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Perfect World had CN¥540.6m of debt, an increase on CN¥450.9m, over one year. But on the other hand it also has CN¥4.43b in cash, leading to a CN¥3.89b net cash position.

A Look At Perfect World's Liabilities

According to the last reported balance sheet, Perfect World had liabilities of CN¥3.74b due within 12 months, and liabilities of CN¥1.55b due beyond 12 months. Offsetting these obligations, it had cash of CN¥4.43b as well as receivables valued at CN¥1.03b due within 12 months. So it can boast CN¥158.6m more liquid assets than total liabilities.

Having regard to Perfect World's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥18.8b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Perfect World boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Perfect World's load is not too heavy, because its EBIT was down 93% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Perfect World's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Perfect World 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. Over the last three years, Perfect World recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Perfect World has CN¥3.89b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of -CN¥4.4m, being 91% of its EBIT. So we are not troubled with Perfect World's debt use. 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. Be aware that Perfect World is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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.