China Medical System Holdings (HKG:867) Seems To Use Debt Rather Sparingly

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.' 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. We note that China Medical System Holdings Limited (HKG:867) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for China Medical System Holdings

How Much Debt Does China Medical System Holdings Carry?

The image below, which you can click on for greater detail, shows that at June 2022 China Medical System Holdings had debt of CN¥1.77b, up from CN¥1.09b in one year. But it also has CN¥5.25b in cash to offset that, meaning it has CN¥3.48b net cash.

How Strong Is China Medical System Holdings' Balance Sheet?

The latest balance sheet data shows that China Medical System Holdings had liabilities of CN¥2.71b due within a year, and liabilities of CN¥315.0m falling due after that. On the other hand, it had cash of CN¥5.25b and CN¥2.42b worth of receivables due within a year. So it can boast CN¥4.65b more liquid assets than total liabilities.

This surplus suggests that China Medical System Holdings is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that China Medical System Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that China Medical System Holdings has increased its EBIT by 9.2% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China Medical System Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China Medical System 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. During the last three years, China Medical System Holdings produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Medical System Holdings has CN¥3.48b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥2.4b, being 79% of its EBIT. So is China Medical System Holdings's debt a risk? It doesn't seem so to us. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check China Medical System Holdings's dividend history, without delay!

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.