Health Check: How Prudently Does Cosmo Lady (China) Holdings (HKG:2298) Use Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Cosmo Lady (China) Holdings Company Limited (HKG:2298) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 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 Cosmo Lady (China) Holdings

What Is Cosmo Lady (China) Holdings's Debt?

The image below, which you can click on for greater detail, shows that Cosmo Lady (China) Holdings had debt of CN¥360.4m at the end of June 2022, a reduction from CN¥477.5m over a year. However, it does have CN¥1.14b in cash offsetting this, leading to net cash of CN¥776.3m.

How Healthy Is Cosmo Lady (China) Holdings' Balance Sheet?

According to the last reported balance sheet, Cosmo Lady (China) Holdings had liabilities of CN¥1.41b due within 12 months, and liabilities of CN¥334.3m due beyond 12 months. On the other hand, it had cash of CN¥1.14b and CN¥259.3m worth of receivables due within a year. So it has liabilities totalling CN¥344.1m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥464.7m, so it does suggest shareholders should keep an eye on Cosmo Lady (China) Holdings' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Cosmo Lady (China) Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Cosmo Lady (China) Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Cosmo Lady (China) Holdings had a loss before interest and tax, and actually shrunk its revenue by 11%, to CN¥3.1b. That's not what we would hope to see.

So How Risky Is Cosmo Lady (China) Holdings?

Statistically speaking companies that lose money are riskier than those that make money. And we do note that Cosmo Lady (China) Holdings had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through CN¥62m of cash and made a loss of CN¥499m. With only CN¥776.3m on the balance sheet, it would appear that its going to need to raise capital again soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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. We've identified 2 warning signs with Cosmo Lady (China) Holdings , and understanding them should be part of your investment process.

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.