Here's Why Brainhole Technology (HKG:2203) Can Afford Some Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Brainhole Technology Limited (HKG:2203) does carry debt. 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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Brainhole Technology

What Is Brainhole Technology's Net Debt?

The image below, which you can click on for greater detail, shows that Brainhole Technology had debt of HK$80.1m at the end of December 2021, a reduction from HK$105.3m over a year. However, because it has a cash reserve of HK$44.4m, its net debt is less, at about HK$35.7m.

A Look At Brainhole Technology's Liabilities

According to the last reported balance sheet, Brainhole Technology had liabilities of HK$123.3m due within 12 months, and liabilities of HK$88.0m due beyond 12 months. Offsetting these obligations, it had cash of HK$44.4m as well as receivables valued at HK$141.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$25.5m.

Brainhole Technology has a market capitalization of HK$100.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Brainhole Technology will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Brainhole Technology wasn't profitable at an EBIT level, but managed to grow its revenue by 23%, to HK$322m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Brainhole Technology still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable HK$34m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of HK$52m into a profit. So we do think this stock is quite risky. 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. Case in point: We've spotted 3 warning signs for Brainhole Technology you should be aware of, and 1 of them is a bit unpleasant.

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.