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 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 Aier Eye Hospital Group Co., Ltd. (SZSE:300015) does have debt on its balance sheet . But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Aier Eye Hospital Group
How Much Debt Does Aier Eye Hospital Group Carry?
As you can see below, Aier Eye Hospital Group had CN¥2.11b of debt at March 2022, down from CN¥2.31b a year prior. However, it does have CN¥4.39b in cash offsetting this, leading to net cash of CN¥2.28b.SZSE:300015 Debt to Equity History August 25th 2022
A Look At Aier Eye Hospital Group's Liabilities
We can see from the most recent balance sheet that Aier Eye Hospital Group had liabilities of CN¥6.01b falling due within a year, and liabilities of CN¥3.47b due beyond that. Offsetting these obligations, it had cash of CN¥4.39b as well as receivables valued at CN¥1.87b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.22b.
This state of affairs indicates that Aier Eye Hospital Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets . So it's very unlikely that the CN¥200.7b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Aier Eye Hospital Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
Fortunately, Aier Eye Hospital Group grew its EBIT by 2.8% in the last year, making that debt load look even more manageable. 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 68% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Aier Eye Hospital Group has CN¥2.28b in net cash. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in CN¥2.9b. So is Aier Eye Hospital Group's debt a risk? It doesn't seem so to us. 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. We've identified 1 warning sign with Aier Eye Hospital Group , and understanding them should be part of your investment process.
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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