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.' 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. As with many other companies Carry Wealth Holdings Limited (HKG:643) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Carry Wealth Holdings

What Is Carry Wealth Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Carry Wealth Holdings had debt of HK$17.7m at the end of June 2022, a reduction from HK$66.1m over a year. However, its balance sheet shows it holds HK$52.7m in cash, so it actually has HK$35.0m net cash.

How Healthy Is Carry Wealth Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Carry Wealth Holdings had liabilities of HK$79.0m due within 12 months and liabilities of HK$18.4m due beyond that. Offsetting these obligations, it had cash of HK$52.7m as well as receivables valued at HK$40.5m due within 12 months. So it has liabilities totalling HK$4.10m more than its cash and near-term receivables, combined.

This state of affairs indicates that Carry Wealth Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the HK$638.1m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Carry Wealth Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

We also note that Carry Wealth Holdings improved its EBIT from a last year's loss to a positive HK$2.5m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Carry Wealth 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Carry Wealth Holdings 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 year, Carry Wealth Holdings 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 it is always sensible to look at a company's total liabilities, it is very reassuring that Carry Wealth Holdings has HK$35.0m in net cash. So although we see some areas for improvement, we're not too worried about Carry Wealth Holdings's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Carry Wealth Holdings .

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.