Does Arts Optical International Holdings (HKG:1120) Have A Healthy Balance Sheet?

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.' 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 can see that Arts Optical International Holdings Limited (HKG:1120) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 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. 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.

View our latest analysis for Arts Optical International Holdings

How Much Debt Does Arts Optical International Holdings Carry?

As you can see below, at the end of June 2024, Arts Optical International Holdings had HK$52.3m of debt, up from HK$3.83m a year ago. Click the image for more detail. But on the other hand it also has HK$124.7m in cash, leading to a HK$72.4m net cash position.

A Look At Arts Optical International Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Arts Optical International Holdings had liabilities of HK$605.1m due within 12 months and liabilities of HK$30.4m due beyond that. On the other hand, it had cash of HK$124.7m and HK$394.6m worth of receivables due within a year. So its liabilities total HK$116.3m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Arts Optical International Holdings is worth HK$386.3m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Arts Optical International Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also good is that Arts Optical International Holdings grew its EBIT at 17% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Arts Optical International Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Arts Optical 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, Arts Optical International Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While Arts Optical International Holdings does have more liabilities than liquid assets, it also has net cash of HK$72.4m. And it impressed us with its EBIT growth of 17% over the last year. So we don't have any problem with Arts Optical International Holdings's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Arts Optical International Holdings (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.