Edvance International Holdings (HKG:1410) Could Easily Take On More Debt

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Edvance International Holdings Limited (HKG:1410) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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, 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.

See our latest analysis for Edvance International Holdings

What Is Edvance International Holdings's Net Debt?

As you can see below, Edvance International Holdings had HK$22.9m of debt at September 2020, down from HK$25.0m a year prior. However, it does have HK$89.3m in cash offsetting this, leading to net cash of HK$66.3m.

How Strong Is Edvance International Holdings's Balance Sheet?

According to the last reported balance sheet, Edvance International Holdings had liabilities of HK$171.0m due within 12 months, and liabilities of HK$73.1m due beyond 12 months. Offsetting this, it had HK$89.3m in cash and HK$97.2m in receivables that were due within 12 months. So its liabilities total HK$57.7m more than the combination of its cash and short-term receivables.

Given Edvance International Holdings has a market capitalization of HK$532.6m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Edvance International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Edvance International Holdings grew its EBIT by 16% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Edvance International Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Edvance International Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Edvance International Holdings produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although Edvance International 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$66.3m. And it impressed us with free cash flow of HK$79m, being 70% of its EBIT. So we don't think Edvance International Holdings's use of debt is 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. For instance, we've identified 1 warning sign for Edvance International Holdings that you should be aware of.

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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