Cabbeen Fashion (HKG:2030) Seems To Use Debt Quite Sensibly

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 note that Cabbeen Fashion Limited (HKG:2030) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Cabbeen Fashion

What Is Cabbeen Fashion's Debt?

As you can see below, Cabbeen Fashion had CN¥251.2m of debt at December 2021, down from CN¥352.1m a year prior. However, its balance sheet shows it holds CN¥536.7m in cash, so it actually has CN¥285.5m net cash.

How Strong Is Cabbeen Fashion's Balance Sheet?

According to the last reported balance sheet, Cabbeen Fashion had liabilities of CN¥1.02b due within 12 months, and liabilities of CN¥27.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥536.7m as well as receivables valued at CN¥603.6m due within 12 months. So it can boast CN¥96.9m more liquid assets than total liabilities.

This surplus suggests that Cabbeen Fashion has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Cabbeen Fashion boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Cabbeen Fashion has seen its EBIT plunge 13% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Cabbeen Fashion will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Cabbeen Fashion 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. In the last three years, Cabbeen Fashion's free cash flow amounted to 27% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Cabbeen Fashion has net cash of CN¥285.5m, as well as more liquid assets than liabilities. So we don't have any problem with Cabbeen Fashion's use of debt. 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 4 warning signs we've spotted with Cabbeen Fashion (including 2 which don't sit too well with us) .

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.