David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Meitu, Inc. (HKG:1357) makes use of debt. But is this debt a concern to shareholders?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is Meitu's Net Debt?

As you can see below, at the end of December 2023, Meitu had CN¥149.6m of debt, up from CN¥10.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.31b in cash, so it actually has CN¥1.16b net cash.

A Look At Meitu's Liabilities

The latest balance sheet data shows that Meitu had liabilities of CN¥1.26b due within a year, and liabilities of CN¥389.1m falling due after that. On the other hand, it had cash of CN¥1.31b and CN¥387.7m worth of receivables due within a year. So it actually has CN¥48.7m more liquid assets than total liabilities.

This state of affairs indicates that Meitu's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥13.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Meitu boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Meitu turned things around in the last 12 months, delivering and EBIT of CN¥291m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Meitu'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. Meitu 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 year, Meitu actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Meitu has net cash of CN¥1.16b, as well as more liquid assets than liabilities. The cherry on top was that in converted 124% of that EBIT to free cash flow, bringing in CN¥361m. So we don't think Meitu'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. Be aware that Meitu is showing 2 warning signs in our investment analysis , you should know about...

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.