Health Check: How Prudently Does Linekong Interactive Group (HKG:8267) Use 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.' 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 Linekong Interactive Group Co., Ltd. (HKG:8267) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Linekong Interactive Group

What Is Linekong Interactive Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Linekong Interactive Group had CN¥50.0m of debt in December 2021, down from CN¥100.0m, one year before. But it also has CN¥195.7m in cash to offset that, meaning it has CN¥145.7m net cash.

A Look At Linekong Interactive Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Linekong Interactive Group had liabilities of CN¥142.0m due within 12 months and liabilities of CN¥2.94m due beyond that. On the other hand, it had cash of CN¥195.7m and CN¥7.92m worth of receivables due within a year. So it can boast CN¥58.7m more liquid assets than total liabilities.

This excess liquidity is a great indication that Linekong Interactive Group's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Linekong Interactive Group has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Linekong Interactive Group 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.

Over 12 months, Linekong Interactive Group made a loss at the EBIT level, and saw its revenue drop to CN¥86m, which is a fall of 59%. To be frank that doesn't bode well.

So How Risky Is Linekong Interactive Group?

While Linekong Interactive Group lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow CN¥24m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. The next few years will be important as the business matures. 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 - Linekong Interactive Group has 2 warning signs we think 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.