The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that Ying Li International Real Estate Limited (SGX:5DM) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

Check out our latest analysis for Ying Li International Real Estate

What Is Ying Li International Real Estate's Net Debt?

The image below, which you can click on for greater detail, shows that Ying Li International Real Estate had debt of CN¥2.24b at the end of December 2024, a reduction from CN¥2.43b over a year. However, because it has a cash reserve of CN¥108.4m, its net debt is less, at about CN¥2.13b.

How Strong Is Ying Li International Real Estate's Balance Sheet?

According to the last reported balance sheet, Ying Li International Real Estate had liabilities of CN¥2.05b due within 12 months, and liabilities of CN¥1.92b due beyond 12 months. Offsetting this, it had CN¥108.4m in cash and CN¥283.8m in receivables that were due within 12 months. So it has liabilities totalling CN¥3.58b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥319.0m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Ying Li International Real Estate would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Ying Li International Real Estate shareholders face the double whammy of a high net debt to EBITDA ratio (155), and fairly weak interest coverage, since EBIT is just 0.065 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Ying Li International Real Estate saw its EBIT tank 78% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ying Li International Real Estate 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Ying Li International Real Estate actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both Ying Li International Real Estate's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. After considering the datapoints discussed, we think Ying Li International Real Estate has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Ying Li International Real Estate that 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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.