Does Zhou Hei Ya International Holdings (HKG:1458) Have A Healthy Balance Sheet?

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 Zhou Hei Ya International Holdings Company Limited (HKG:1458) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

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What Is Zhou Hei Ya International Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Zhou Hei Ya International Holdings had debt of CN¥1.48b, up from CN¥1.35b in one year. But it also has CN¥3.16b in cash to offset that, meaning it has CN¥1.68b net cash.

How Strong Is Zhou Hei Ya International Holdings' Balance Sheet?

The latest balance sheet data shows that Zhou Hei Ya International Holdings had liabilities of CN¥1.03b due within a year, and liabilities of CN¥1.52b falling due after that. On the other hand, it had cash of CN¥3.16b and CN¥100.6m worth of receivables due within a year. So it can boast CN¥717.2m more liquid assets than total liabilities.

This surplus suggests that Zhou Hei Ya International Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Zhou Hei Ya International Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Zhou Hei Ya International Holdings's load is not too heavy, because its EBIT was down 83% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhou Hei Ya International Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Zhou Hei Ya International 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. Happily for any shareholders, Zhou Hei Ya International Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhou Hei Ya International Holdings has net cash of CN¥1.68b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥275m, being 189% of its EBIT. So we are not troubled with Zhou Hei Ya International Holdings's debt use. 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. For instance, we've identified 1 warning sign for Zhou Hei Ya International Holdings that you should be aware of.

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.