Yincheng Life Service (HKG:1922) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Yincheng Life Service CO., Ltd. (HKG:1922) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. 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 Yincheng Life Service

What Is Yincheng Life Service's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Yincheng Life Service had debt of CN¥157.0m, up from CN¥82.0m in one year. However, it does have CN¥309.5m in cash offsetting this, leading to net cash of CN¥152.5m.

A Look At Yincheng Life Service's Liabilities

Zooming in on the latest balance sheet data, we can see that Yincheng Life Service had liabilities of CN¥749.2m due within 12 months and liabilities of CN¥21.3m due beyond that. On the other hand, it had cash of CN¥309.5m and CN¥478.2m worth of receivables due within a year. So it can boast CN¥17.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Yincheng Life Service could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Yincheng Life Service has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Yincheng Life Service grew its EBIT by 37% over the last twelve months, and that growth will make it easier to handle its debt. 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 Yincheng Life Service will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Yincheng Life Service 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. In the last three years, Yincheng Life Service's free cash flow amounted to 29% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Yincheng Life Service has CN¥152.5m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 37% over the last year. So we don't think Yincheng Life Service's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for Yincheng Life Service (1 is concerning!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.