These 4 Measures Indicate That E. Bon Holdings (HKG:599) Is Using Debt Reasonably Well

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 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 E. Bon Holdings Limited (HKG:599) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for E. Bon Holdings

What Is E. Bon Holdings's Net Debt?

As you can see below, at the end of September 2021, E. Bon Holdings had HK$54.3m of debt, up from HK$51.6m a year ago. Click the image for more detail. However, its balance sheet shows it holds HK$84.4m in cash, so it actually has HK$30.2m net cash.

How Strong Is E. Bon Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that E. Bon Holdings had liabilities of HK$187.0m due within 12 months and liabilities of HK$55.8m due beyond that. On the other hand, it had cash of HK$84.4m and HK$149.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$9.11m.

Since publicly traded E. Bon Holdings shares are worth a total of HK$291.3m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, E. Bon Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that E. Bon Holdings's EBIT was down 22% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is E. Bon Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. E. Bon Holdings 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, E. Bon Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that E. Bon Holdings has HK$30.2m in net cash. The cherry on top was that in converted 324% of that EBIT to free cash flow, bringing in HK$51m. So we are not troubled with E. Bon Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for E. Bon Holdings (of which 1 can't be ignored!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.