Is Fineland Living Services Group (HKG:9978) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Fineland Living Services Group Limited (HKG:9978) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

Check out our latest analysis for Fineland Living Services Group

How Much Debt Does Fineland Living Services Group Carry?

As you can see below, at the end of December 2022, Fineland Living Services Group had CN¥35.7m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has CN¥118.2m in cash, leading to a CN¥82.5m net cash position.

A Look At Fineland Living Services Group's Liabilities

The latest balance sheet data shows that Fineland Living Services Group had liabilities of CN¥319.0m due within a year, and liabilities of CN¥17.4m falling due after that. Offsetting these obligations, it had cash of CN¥118.2m as well as receivables valued at CN¥335.5m due within 12 months. So it can boast CN¥117.4m more liquid assets than total liabilities.

This surplus liquidity suggests that Fineland Living Services Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Fineland Living Services Group has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Fineland Living Services Group's EBIT dived 16%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is Fineland Living Services Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Fineland Living Services Group 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. Looking at the most recent three years, Fineland Living Services Group recorded free cash flow of 50% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, the bottom line is that Fineland Living Services Group has net cash of CN¥82.5m and plenty of liquid assets. So we don't think Fineland Living Services Group's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Fineland Living Services Group has 2 warning signs (and 1 which makes us a bit uncomfortable) we think 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.