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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Shanghai Chicmax Cosmetic Co., Ltd. (HKG:2145) does use debt in its business. But the real question is whether this debt is making the company risky.
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Shanghai Chicmax Cosmetic
The image below, which you can click on for greater detail, shows that Shanghai Chicmax Cosmetic had debt of CN¥60.0m at the end of June 2024, a reduction from CN¥259.4m over a year. But on the other hand it also has CN¥857.8m in cash, leading to a CN¥797.8m net cash position.
We can see from the most recent balance sheet that Shanghai Chicmax Cosmetic had liabilities of CN¥1.31b falling due within a year, and liabilities of CN¥35.8m due beyond that. Offsetting these obligations, it had cash of CN¥857.8m as well as receivables valued at CN¥318.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥164.7m.
Having regard to Shanghai Chicmax Cosmetic's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥16.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Shanghai Chicmax Cosmetic also has more cash than debt, so we're pretty confident it can manage its debt safely.
Even more impressive was the fact that Shanghai Chicmax Cosmetic grew its EBIT by 716% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shanghai Chicmax Cosmetic's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shanghai Chicmax Cosmetic 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. Over the last three years, Shanghai Chicmax Cosmetic recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Shanghai Chicmax Cosmetic has CN¥797.8m in net cash. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in CN¥619m. So we don't think Shanghai Chicmax Cosmetic'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. Case in point: We've spotted 1 warning sign for Shanghai Chicmax Cosmetic 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.