Does Kidztech Holdings (HKG:6918) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Kidztech Holdings Limited (HKG:6918) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Kidztech Holdings

What Is Kidztech Holdings's Net Debt?

As you can see below, at the end of December 2021, Kidztech Holdings had CN¥167.0m of debt, up from CN¥155.9m a year ago. Click the image for more detail. However, it does have CN¥292.6m in cash offsetting this, leading to net cash of CN¥125.6m.

How Strong Is Kidztech Holdings' Balance Sheet?

According to the last reported balance sheet, Kidztech Holdings had liabilities of CN¥328.7m due within 12 months, and liabilities of CN¥10.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥292.6m as well as receivables valued at CN¥126.9m due within 12 months. So it actually has CN¥80.3m more liquid assets than total liabilities.

It's good to see that Kidztech Holdings has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Kidztech Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Kidztech Holdings saw its EBIT drop by 7.4% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is Kidztech Holdings's earnings that will influence how the balance sheet holds up in the future. 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. Kidztech Holdings 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. During the last three years, Kidztech Holdings generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kidztech Holdings has net cash of CN¥125.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥156m, being 98% of its EBIT. So is Kidztech Holdings's debt a risk? It doesn't seem so to us. 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. Be aware that Kidztech Holdings is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

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.