Is Zengame Technology Holding (HKG:2660) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Zengame Technology Holding Limited (HKG:2660) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Zengame Technology Holding

What Is Zengame Technology Holding's Debt?

As you can see below, at the end of June 2023, Zengame Technology Holding had CN¥12.0m of debt, up from none a year ago. Click the image for more detail. But it also has CN¥1.67b in cash to offset that, meaning it has CN¥1.65b net cash.

How Healthy Is Zengame Technology Holding's Balance Sheet?

We can see from the most recent balance sheet that Zengame Technology Holding had liabilities of CN¥464.5m falling due within a year, and liabilities of CN¥2.21m due beyond that. On the other hand, it had cash of CN¥1.67b and CN¥179.3m worth of receivables due within a year. So it can boast CN¥1.38b more liquid assets than total liabilities.

This excess liquidity suggests that Zengame Technology Holding is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Zengame Technology Holding has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Zengame Technology Holding has boosted its EBIT by 43%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Zengame Technology Holding will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Zengame Technology Holding 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, Zengame Technology Holding recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zengame Technology Holding has CN¥1.65b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥931m, being 95% of its EBIT. When it comes to Zengame Technology Holding's debt, we sufficiently relaxed that our mind turns to the jacuzzi. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Zengame Technology Holding you should know about.

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.