Here's Why Expert Systems Holdings (HKG:8319) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Expert Systems Holdings Limited (HKG:8319) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Expert Systems Holdings

What Is Expert Systems Holdings's Net Debt?

As you can see below, at the end of March 2022, Expert Systems Holdings had HK$56.5m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has HK$201.4m in cash, leading to a HK$144.9m net cash position.

How Strong Is Expert Systems Holdings' Balance Sheet?

According to the last reported balance sheet, Expert Systems Holdings had liabilities of HK$300.4m due within 12 months, and liabilities of HK$68.5m due beyond 12 months. Offsetting these obligations, it had cash of HK$201.4m as well as receivables valued at HK$146.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$21.5m.

Expert Systems Holdings has a market capitalization of HK$102.8m, 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. While it does have liabilities worth noting, Expert Systems Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that Expert Systems Holdings grew its EBIT by 15% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Expert Systems Holdings will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Expert Systems 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. Happily for any shareholders, Expert Systems Holdings actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

Although Expert Systems 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 HK$144.9m. And it impressed us with free cash flow of HK$51m, being 214% of its EBIT. So we don't think Expert Systems Holdings's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Expert Systems Holdings you should be aware of.

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.