Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Luks Group (Vietnam Holdings) Company Limited (HKG:366) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Luks Group (Vietnam Holdings)

How Much Debt Does Luks Group (Vietnam Holdings) Carry?

The image below, which you can click on for greater detail, shows that at June 2019 Luks Group (Vietnam Holdings) had debt of HK$80.0m, up from HK$76.5 in one year. But it also has HK$395.4m in cash to offset that, meaning it has HK$315.4m net cash.

How Strong Is Luks Group (Vietnam Holdings)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Luks Group (Vietnam Holdings) had liabilities of HK$232.7m due within 12 months and liabilities of HK$229.5m due beyond that. Offsetting this, it had HK$395.4m in cash and HK$64.1m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Luks Group (Vietnam Holdings)'s size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the HK$768.1m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Luks Group (Vietnam Holdings) boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Luks Group (Vietnam Holdings) has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Luks Group (Vietnam 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Luks Group (Vietnam 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 three years, Luks Group (Vietnam Holdings) recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Luks Group (Vietnam Holdings) has HK$315.4m in net cash. And it impressed us with free cash flow of HK$214m, being 95% of its EBIT. So is Luks Group (Vietnam Holdings)'s debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 3 warning signs we've spotted with Luks Group (Vietnam Holdings) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.