A-Living Smart City Services (HKG:3319) Could Easily Take On More Debt

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. As with many other companies A-Living Smart City Services Co., Ltd. (HKG:3319) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for A-Living Smart City Services

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

The image below, which you can click on for greater detail, shows that at June 2022 A-Living Smart City Services had debt of CN¥235.4m, up from CN¥61.4m in one year. However, its balance sheet shows it holds CN¥6.01b in cash, so it actually has CN¥5.77b net cash.

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¥7.76b falling due within a year, and liabilities of CN¥505.1m due beyond that. Offsetting these obligations, it had cash of CN¥6.01b as well as receivables valued at CN¥8.00b due within 12 months. So it can boast CN¥5.74b 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. Succinctly put, A-Living Smart City Services boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that A-Living Smart City Services has increased its EBIT by 3.5% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine A-Living Smart City Services'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While A-Living Smart City Services 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. During the last three years, A-Living Smart City Services produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case A-Living Smart City Services has CN¥5.77b 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. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with A-Living Smart City Services (at least 1 which is significant) , and understanding them should be part of your investment process.

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.