Is Virtual Mind Holding (HKG:1520) Using Debt Sensibly?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Virtual Mind Holding Company Limited (HKG:1520) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for Virtual Mind Holding

What Is Virtual Mind Holding's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Virtual Mind Holding had HK$39.5m of debt, an increase on HK$28.1m, over one year. But on the other hand it also has HK$92.1m in cash, leading to a HK$52.6m net cash position.

How Strong Is Virtual Mind Holding's Balance Sheet?

According to the last reported balance sheet, Virtual Mind Holding had liabilities of HK$90.5m due within 12 months, and liabilities of HK$1.40m due beyond 12 months. Offsetting this, it had HK$92.1m in cash and HK$81.7m in receivables that were due within 12 months. So it actually has HK$81.9m more liquid assets than total liabilities.

This excess liquidity is a great indication that Virtual Mind Holding's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Virtual Mind Holding 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 Virtual Mind Holding 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 Virtual Mind Holding had a loss before interest and tax, and actually shrunk its revenue by 35%, to HK$64m. That makes us nervous, to say the least.

So How Risky Is Virtual Mind Holding?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months Virtual Mind Holding lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through HK$50m of cash and made a loss of HK$101m. But at least it has HK$52.6m on the balance sheet to spend on growth, near-term. 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. 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. For instance, we've identified 4 warning signs for Virtual Mind Holding (2 don't sit too well with us) you should be aware of.

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.