China Ruyi Holdings (HKG:136) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that China Ruyi Holdings Limited (HKG:136) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for China Ruyi Holdings

What Is China Ruyi Holdings's Debt?

As you can see below, China Ruyi Holdings had CN¥1.88b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥2.95b in cash to offset that, meaning it has CN¥1.07b net cash.

How Strong Is China Ruyi Holdings' Balance Sheet?

We can see from the most recent balance sheet that China Ruyi Holdings had liabilities of CN¥4.48b falling due within a year, and liabilities of CN¥2.24b due beyond that. Offsetting this, it had CN¥2.95b in cash and CN¥4.10b in receivables that were due within 12 months. So it actually has CN¥330.4m more liquid assets than total liabilities.

This state of affairs indicates that China Ruyi Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥24.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, China Ruyi Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Although China Ruyi Holdings made a loss at the EBIT level, last year, it was also good to see that it generated CN¥2.3b in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if China Ruyi Holdings can strengthen its balance sheet over time. 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. While China Ruyi 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. In the last year, China Ruyi Holdings's free cash flow amounted to 34% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Ruyi Holdings has CN¥1.07b in net cash and a decent-looking balance sheet. So we don't have any problem with China Ruyi Holdings's use of debt. 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. For example, we've discovered 3 warning signs for China Ruyi Holdings that you should be aware of before investing here.

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.