Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Elife Holdings Limited (HKG:223) has a debt on its balance sheet. But should shareholders worry about its use of debt?
Why is debt risky?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Elife Holdings
How much debt does Elife Holdings bear?
You can click on the graph below for historical numbers, but it shows that in March 2022, Elife Holdings had HK$25.8 million in debt, an increase of HK$23.7 million, on a year. However, he also had HK$11.7 million in cash, so his net debt is HK$14.2 million.
How strong is Elife Holdings’ balance sheet?
The latest balance sheet data shows that Elife Holdings had liabilities of HK$56.3 million due within the year, and liabilities of HK$1.66 million falling due thereafter. As compensation for these obligations, it had liquid assets of HK$11.7 million as well as receivables valued at HK$48.6 million and payable within 12 months. He can therefore boast that he has HK$2.33 million more in cash than total Passives.
This short-term liquidity is a sign that Elife Holdings could probably service its debt easily, as its balance sheet is far from stretched. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since Elife Holdings will need income to repay this debt. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.
Over 12 months, Elife Holdings recorded a loss in EBIT and saw its revenue drop to HK$153 million, a decline of 45%. To be honest, that doesn’t bode well.
Not only did Elife Holdings’ revenues fall over the past twelve months, but it also produced negative earnings before interest and taxes (EBIT). Its EBIT loss was HK$48 million. On the plus side, the company has adequate liquid assets, giving it time to grow and expand before its debt becomes a short-term problem. But a profit would do more to inspire us to seek out the company more closely. So it seems too risky for our taste. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Elife Holdings you should know.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.