EEKA Fashion Holdings (HKG:3709) Has A Pretty 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.' 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 can see that EEKA Fashion Holdings Limited (HKG:3709) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

View our latest analysis for EEKA Fashion Holdings

What Is EEKA Fashion Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 EEKA Fashion Holdings had CN¥366.5m of debt, an increase on CN¥262.2m, over one year. However, its balance sheet shows it holds CN¥863.4m in cash, so it actually has CN¥496.9m net cash.

A Look At EEKA Fashion Holdings' Liabilities

We can see from the most recent balance sheet that EEKA Fashion Holdings had liabilities of CN¥1.69b falling due within a year, and liabilities of CN¥579.2m due beyond that. Offsetting this, it had CN¥863.4m in cash and CN¥673.1m in receivables that were due within 12 months. So its liabilities total CN¥730.8m more than the combination of its cash and short-term receivables.

Of course, EEKA Fashion Holdings has a market capitalization of CN¥5.79b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, EEKA Fashion Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, EEKA Fashion Holdings saw its EBIT drop by 3.6% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if EEKA Fashion Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. EEKA Fashion Holdings 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 last three years, EEKA Fashion Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While EEKA Fashion Holdings does have more liabilities than liquid assets, it also has net cash of CN¥496.9m. The cherry on top was that in converted 157% of that EBIT to free cash flow, bringing in CN¥984m. So we don't think EEKA Fashion Holdings's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with EEKA Fashion Holdings .

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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