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

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.' 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 is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See 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 EEKA Fashion Holdings had CN¥430.3m of debt in December 2022, down from CN¥491.3m, one year before. However, its balance sheet shows it holds CN¥880.0m in cash, so it actually has CN¥449.7m net cash.

How Healthy Is EEKA Fashion Holdings' Balance Sheet?

According to the last reported balance sheet, EEKA Fashion Holdings had liabilities of CN¥1.65b due within 12 months, and liabilities of CN¥621.3m due beyond 12 months. Offsetting this, it had CN¥880.0m in cash and CN¥472.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥917.4m.

Given EEKA Fashion Holdings has a market capitalization of CN¥6.41b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, EEKA Fashion Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact EEKA Fashion Holdings's saving grace is its low debt levels, because its EBIT has tanked 42% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

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¥449.7m. And it impressed us with free cash flow of CN¥1.5b, being 242% of its EBIT. So we don't have any problem with EEKA Fashion Holdings's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that EEKA Fashion Holdings is showing 2 warning signs in our investment analysis , you should know about...

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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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.