Here's Why Quali-Smart Holdings (HKG:1348) Can Afford Some 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 note that Quali-Smart Holdings Limited (HKG:1348) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Quali-Smart Holdings

How Much Debt Does Quali-Smart Holdings Carry?

As you can see below, at the end of March 2022, Quali-Smart Holdings had HK$72.6m of debt, up from HK$51.0m a year ago. Click the image for more detail. On the flip side, it has HK$30.5m in cash leading to net debt of about HK$42.2m.

How Strong Is Quali-Smart Holdings' Balance Sheet?

The latest balance sheet data shows that Quali-Smart Holdings had liabilities of HK$151.1m due within a year, and liabilities of HK$31.7m falling due after that. On the other hand, it had cash of HK$30.5m and HK$92.7m worth of receivables due within a year. So it has liabilities totalling HK$59.6m more than its cash and near-term receivables, combined.

Of course, Quali-Smart Holdings has a market capitalization of HK$322.9m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Quali-Smart Holdings 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.

In the last year Quali-Smart Holdings had a loss before interest and tax, and actually shrunk its revenue by 7.6%, to HK$449m. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Quali-Smart Holdings produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping HK$37m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled HK$43m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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. To that end, you should learn about the 3 warning signs we've spotted with Quali-Smart Holdings (including 2 which are a bit unpleasant) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.