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 Aier Eye Hospital Group Co., Ltd. (SZSE:300015) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Aier Eye Hospital Group Carry?
The image below, which you can click on for greater detail, shows that at March 2024 Aier Eye Hospital Group had debt of CN¥1.66b, up from CN¥1.34b in one year. But on the other hand it also has CN¥7.44b in cash, leading to a CN¥5.78b net cash position.
A Look At Aier Eye Hospital Group's Liabilities
According to the last reported balance sheet, Aier Eye Hospital Group had liabilities of CN¥5.86b due within 12 months, and liabilities of CN¥4.11b due beyond 12 months. On the other hand, it had cash of CN¥7.44b and CN¥2.36b worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
Having regard to Aier Eye Hospital Group'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¥119.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Aier Eye Hospital Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, Aier Eye Hospital Group grew its EBIT by 28% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Aier Eye Hospital Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Aier Eye Hospital Group 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. During the last three years, Aier Eye Hospital Group produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
We could understand if investors are concerned about Aier Eye Hospital Group's liabilities, but we can be reassured by the fact it has has net cash of CN¥5.78b. And we liked the look of last year's 28% year-on-year EBIT growth. So we don't think Aier Eye Hospital Group's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Aier Eye Hospital Group has 1 warning sign we think you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.