Here's Why Wisdom Education International Holdings (HKG:6068) Can Manage Its Debt Responsibly

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Wisdom Education International Holdings Company Limited (HKG:6068) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. 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.

View our latest analysis for Wisdom Education International Holdings

What Is Wisdom Education International Holdings's Net Debt?

As you can see below, Wisdom Education International Holdings had CN¥174.3m of debt at August 2021, down from CN¥2.79b a year prior. But it also has CN¥1.31b in cash to offset that, meaning it has CN¥1.14b net cash.

A Look At Wisdom Education International Holdings' Liabilities

We can see from the most recent balance sheet that Wisdom Education International Holdings had liabilities of CN¥824.6m falling due within a year, and liabilities of CN¥2.24m due beyond that. On the other hand, it had cash of CN¥1.31b and CN¥4.33m worth of receivables due within a year. So it can boast CN¥488.0m more liquid assets than total liabilities.

This surplus strongly suggests that Wisdom Education International Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Wisdom Education International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Wisdom Education International Holdings grew its EBIT by 17% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Wisdom Education International Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Wisdom Education International Holdings 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. Over the last three years, Wisdom Education International Holdings recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Wisdom Education International Holdings has net cash of CN¥1.14b, as well as more liquid assets than liabilities. And we liked the look of last year's 17% year-on-year EBIT growth. So is Wisdom Education International Holdings's debt a risk? It doesn't seem so to us. 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. Be aware that Wisdom Education International Holdings is showing 1 warning sign in our investment analysis , you should know about...

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.