Is A-Living Smart City Services (HKG:3319) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 A-Living Smart City Services Co., Ltd. (HKG:3319) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 A-Living Smart City Services

What Is A-Living Smart City Services's Net Debt?

As you can see below, at the end of December 2022, A-Living Smart City Services had CN¥104.8m of debt, up from CN¥78.5m a year ago. Click the image for more detail. However, it does have CN¥4.84b in cash offsetting this, leading to net cash of CN¥4.74b.

How Healthy Is A-Living Smart City Services' Balance Sheet?

We can see from the most recent balance sheet that A-Living Smart City Services had liabilities of CN¥8.19b falling due within a year, and liabilities of CN¥389.0m due beyond that. Offsetting this, it had CN¥4.84b in cash and CN¥9.97b in receivables that were due within 12 months. So it can boast CN¥6.24b more liquid assets than total liabilities.

This excess liquidity is a great indication that A-Living Smart City Services' balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that A-Living Smart City Services has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for A-Living Smart City Services if management cannot prevent a repeat of the 27% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 A-Living Smart City Services 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. A-Living Smart City Services 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. Over the most recent three years, A-Living Smart City Services recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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 A-Living Smart City Services has CN¥4.74b in net cash and a decent-looking balance sheet. So is A-Living Smart City Services's debt a risk? It doesn't seem so to us. 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. We've identified 1 warning sign with A-Living Smart City Services , and understanding them should be part of your investment process.

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.