China Environmental Energy Investment (HKG:986) Seems To Use Debt Quite Sensibly

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 China Environmental Energy Investment Limited (HKG:986) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for China Environmental Energy Investment

What Is China Environmental Energy Investment's Net Debt?

You can click the graphic below for the historical numbers, but it shows that China Environmental Energy Investment had HK$17.3m of debt in September 2021, down from HK$26.1m, one year before. But on the other hand it also has HK$50.1m in cash, leading to a HK$32.8m net cash position.

A Look At China Environmental Energy Investment's Liabilities

Zooming in on the latest balance sheet data, we can see that China Environmental Energy Investment had liabilities of HK$24.3m due within 12 months and liabilities of HK$18.2m due beyond that. On the other hand, it had cash of HK$50.1m and HK$142.0m worth of receivables due within a year. So it can boast HK$149.6m more liquid assets than total liabilities.

This luscious liquidity implies that China Environmental Energy Investment's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that China Environmental Energy Investment has more cash than debt is arguably a good indication that it can manage its debt safely.

Although China Environmental Energy Investment made a loss at the EBIT level, last year, it was also good to see that it generated HK$13m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Environmental Energy Investment'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While China Environmental Energy Investment 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. During the last year, China Environmental Energy Investment burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case China Environmental Energy Investment has HK$32.8m in net cash and a strong balance sheet. So we don't have any problem with China Environmental Energy Investment's use of debt. 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 4 warning signs we've spotted with China Environmental Energy Investment (including 1 which shouldn't be ignored) .

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.