Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Quali-Smart Holdings Limited (HKG:1348) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, 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 capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Quali-Smart Holdings

How Much Debt Does Quali-Smart Holdings Carry?

The image below, which you can click on for greater detail, shows that Quali-Smart Holdings had debt of HK$37.1m at the end of March 2024, a reduction from HK$39.0m over a year. But on the other hand it also has HK$79.2m in cash, leading to a HK$42.0m net cash position.

A Look At Quali-Smart Holdings' Liabilities

The latest balance sheet data shows that Quali-Smart Holdings had liabilities of HK$82.7m due within a year, and liabilities of HK$37.7m falling due after that. On the other hand, it had cash of HK$79.2m and HK$25.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$16.2m.

Given Quali-Smart Holdings has a market capitalization of HK$109.1m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Quali-Smart Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Quali-Smart Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Quali-Smart Holdings made a loss at the EBIT level, and saw its revenue drop to HK$177m, which is a fall of 48%. To be frank that doesn't bode well.

So How Risky Is Quali-Smart Holdings?

Although Quali-Smart Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of HK$23m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. 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. To that end, you should learn about the 3 warning signs we've spotted with Quali-Smart Holdings (including 2 which make us uncomfortable) .

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.

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.