Spring Art Holdings Berhad (KLSE:SPRING) Seems To Use Debt Quite Sensibly

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.' 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 Spring Art Holdings Berhad (KLSE:SPRING) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

Check out our latest analysis for Spring Art Holdings Berhad

How Much Debt Does Spring Art Holdings Berhad Carry?

The image below, which you can click on for greater detail, shows that Spring Art Holdings Berhad had debt of RM15.0m at the end of December 2023, a reduction from RM15.8m over a year. But it also has RM17.2m in cash to offset that, meaning it has RM2.20m net cash.

How Strong Is Spring Art Holdings Berhad's Balance Sheet?

We can see from the most recent balance sheet that Spring Art Holdings Berhad had liabilities of RM9.45m falling due within a year, and liabilities of RM17.8m due beyond that. Offsetting these obligations, it had cash of RM17.2m as well as receivables valued at RM12.1m due within 12 months. So it can boast RM2.06m more liquid assets than total liabilities.

This short term liquidity is a sign that Spring Art Holdings Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Spring Art Holdings Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Spring Art Holdings Berhad grew its EBIT by 142% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is Spring Art Holdings Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Spring Art Holdings Berhad 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. Over the last three years, Spring Art Holdings Berhad saw substantial negative free cash flow, in total. 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 we empathize with investors who find debt concerning, you should keep in mind that Spring Art Holdings Berhad has net cash of RM2.20m, as well as more liquid assets than liabilities. And we liked the look of last year's 142% year-on-year EBIT growth. So we don't have any problem with Spring Art Holdings Berhad's use of debt. 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. We've identified 2 warning signs with Spring Art Holdings Berhad (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.