Does Topsports International Holdings (HKG:6110) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Topsports International Holdings Limited (HKG:6110) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Topsports International Holdings

What Is Topsports International Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Topsports International Holdings had CN¥840.0m of debt in August 2023, down from CN¥2.03b, one year before. However, it does have CN¥3.15b in cash offsetting this, leading to net cash of CN¥2.31b.

How Strong Is Topsports International Holdings' Balance Sheet?

We can see from the most recent balance sheet that Topsports International Holdings had liabilities of CN¥4.02b falling due within a year, and liabilities of CN¥1.51b due beyond that. On the other hand, it had cash of CN¥3.15b and CN¥1.75b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥629.7m.

Having regard to Topsports International Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥32.6b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Topsports International Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Topsports International Holdings saw its EBIT decline by 9.8% over the last year. 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 Topsports International 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, a company can only pay off debt with cold hard cash, not accounting profits. While Topsports International 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, Topsports International 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

We could understand if investors are concerned about Topsports International Holdings's liabilities, but we can be reassured by the fact it has has net cash of CN¥2.31b. And it impressed us with free cash flow of CN¥4.9b, being 138% of its EBIT. So we don't think Topsports International Holdings's use of debt is risky. 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 1 warning sign with Topsports International Holdings , 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.