EEKA Fashion Holdings (HKG:3709) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that EEKA Fashion Holdings Limited (HKG:3709) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out the opportunities and risks within the HK Specialty Retail industry.

How Much Debt Does EEKA Fashion Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that EEKA Fashion Holdings had CN¥399.7m of debt in June 2022, down from CN¥452.3m, one year before. But it also has CN¥857.3m in cash to offset that, meaning it has CN¥457.6m net cash.

How Healthy Is EEKA Fashion Holdings' Balance Sheet?

The latest balance sheet data shows that EEKA Fashion Holdings had liabilities of CN¥1.50b due within a year, and liabilities of CN¥654.3m falling due after that. On the other hand, it had cash of CN¥857.3m and CN¥532.8m worth of receivables due within a year. So it has liabilities totalling CN¥759.5m more than its cash and near-term receivables, combined.

Of course, EEKA Fashion Holdings has a market capitalization of CN¥6.10b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. 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 8.3% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While EEKA Fashion Holdings 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 last three years, EEKA Fashion Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although EEKA Fashion Holdings'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¥457.6m. The cherry on top was that in converted 209% of that EBIT to free cash flow, bringing in CN¥1.2b. So we don't have any problem with EEKA Fashion Holdings's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with EEKA Fashion Holdings .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.