Health Check: How Prudently Does Sinofortune Financial Holdings (HKG:8123) Use Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Sinofortune Financial Holdings Limited (HKG:8123) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Sinofortune Financial Holdings

What Is Sinofortune Financial Holdings's Net Debt?

As you can see below, at the end of December 2022, Sinofortune Financial Holdings had HK$25.0m of debt, up from HK$10.0m a year ago. Click the image for more detail. But it also has HK$33.7m in cash to offset that, meaning it has HK$8.75m net cash.

How Strong Is Sinofortune Financial Holdings' Balance Sheet?

We can see from the most recent balance sheet that Sinofortune Financial Holdings had liabilities of HK$91.9m falling due within a year, and liabilities of HK$3.47m due beyond that. On the other hand, it had cash of HK$33.7m and HK$2.51m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$59.1m.

This deficit is considerable relative to its market capitalization of HK$85.2m, so it does suggest shareholders should keep an eye on Sinofortune Financial Holdings' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Sinofortune Financial Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sinofortune Financial Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Sinofortune Financial Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 648%, to HK$181m. That's virtually the hole-in-one of revenue growth!

So How Risky Is Sinofortune Financial Holdings?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Sinofortune Financial Holdings lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of HK$28m and booked a HK$31m accounting loss. But the saving grace is the HK$8.75m on the balance sheet. That means it could keep spending at its current rate for more than two years. Importantly, Sinofortune Financial Holdings's revenue growth is hot to trot. High growth pre-profit companies may well be risky, but they can also offer great rewards. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Sinofortune Financial Holdings (including 1 which is significant) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.