These 4 Measures Indicate That Scholar Education Group (HKG:1769) Is Using Debt Safely

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. As with many other companies Scholar Education Group (HKG:1769) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Scholar Education Group

What Is Scholar Education Group's Debt?

As you can see below, at the end of June 2024, Scholar Education Group had CN¥30.0m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥419.2m in cash, so it actually has CN¥389.2m net cash.

A Look At Scholar Education Group's Liabilities

The latest balance sheet data shows that Scholar Education Group had liabilities of CN¥459.3m due within a year, and liabilities of CN¥173.2m falling due after that. Offsetting these obligations, it had cash of CN¥419.2m as well as receivables valued at CN¥9.22m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥204.0m.

Given Scholar Education Group has a market capitalization of CN¥3.20b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Scholar Education Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Scholar Education Group grew its EBIT by 144% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Scholar Education Group'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Scholar Education Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Scholar Education Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

We could understand if investors are concerned about Scholar Education Group's liabilities, but we can be reassured by the fact it has has net cash of CN¥389.2m. The cherry on top was that in converted 121% of that EBIT to free cash flow, bringing in CN¥181m. So we don't think Scholar Education Group's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Scholar Education Group you should be aware of.

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.