Does Colour Life Services Group (HKG:1778) Have A Healthy Balance Sheet?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Colour Life Services Group Co., Limited (HKG:1778) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Colour Life Services Group

What Is Colour Life Services Group's Debt?

As you can see below, Colour Life Services Group had CN¥2.34b of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥2.71b in cash offsetting this, leading to net cash of CN¥375.7m.

How Healthy Is Colour Life Services Group's Balance Sheet?

According to the last reported balance sheet, Colour Life Services Group had liabilities of CN¥4.21b due within 12 months, and liabilities of CN¥1.23b due beyond 12 months. On the other hand, it had cash of CN¥2.71b and CN¥1.52b worth of receivables due within a year. So it has liabilities totalling CN¥1.20b more than its cash and near-term receivables, combined.

Colour Life Services Group has a market capitalization of CN¥2.76b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Colour Life Services Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

The bad news is that Colour Life Services Group saw its EBIT decline by 14% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Colour Life Services Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Colour Life Services Group 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 most recent three years, Colour Life Services Group recorded free cash flow worth 75% 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

Although Colour Life Services Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥375.7m. And it impressed us with free cash flow of CN¥796m, being 75% of its EBIT. So we don't have any problem with Colour Life Services Group's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Colour Life Services Group you should be aware of.

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.
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