Health Check: How Prudently Does Luxxu Group (HKG:1327) Use Debt?

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.' 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. We can see that Luxxu Group Limited (HKG:1327) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

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What Is Luxxu Group's Debt?

As you can see below, at the end of June 2022, Luxxu Group had CN¥23.7m of debt, up from CN¥14.6m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥63.9m in cash, so it actually has CN¥40.2m net cash.

How Strong Is Luxxu Group's Balance Sheet?

According to the last reported balance sheet, Luxxu Group had liabilities of CN¥10.4m due within 12 months, and liabilities of CN¥20.7m due beyond 12 months. On the other hand, it had cash of CN¥63.9m and CN¥47.7m worth of receivables due within a year. So it can boast CN¥80.4m more liquid assets than total liabilities.

This surplus strongly suggests that Luxxu Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Luxxu Group has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Luxxu Group will need earnings to service that debt. 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.

Over 12 months, Luxxu Group reported revenue of CN¥75m, which is a gain of 6.5%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Luxxu Group?

Statistically speaking companies that lose money are riskier than those that make money. And we do note that Luxxu Group had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through CN¥7.9m of cash and made a loss of CN¥52m. While this does make the company a bit risky, it's important to remember it has net cash of CN¥40.2m. That means it could keep spending at its current rate for more than two years. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Luxxu Group (including 1 which is significant) .

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.