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. 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 Kingsmen Creatives Ltd. (SGX:5MZ) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Kingsmen Creatives

How Much Debt Does Kingsmen Creatives Carry?

The image below, which you can click on for greater detail, shows that Kingsmen Creatives had debt of S$33.4m at the end of December 2019, a reduction from S$35.6m over a year. However, it does have S$67.6m in cash offsetting this, leading to net cash of S$34.2m.

How Strong Is Kingsmen Creatives's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kingsmen Creatives had liabilities of S$142.5m due within 12 months and liabilities of S$29.1m due beyond that. Offsetting this, it had S$67.6m in cash and S$122.6m in receivables that were due within 12 months. So it can boast S$18.6m more liquid assets than total liabilities.

This luscious liquidity implies that Kingsmen Creatives's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Simply put, the fact that Kingsmen Creatives has more cash than debt is arguably a good indication that it can manage its debt safely.

Shareholders should be aware that Kingsmen Creatives's EBIT was down 93% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kingsmen Creatives 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Kingsmen Creatives 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. During the last three years, Kingsmen Creatives burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case Kingsmen Creatives has S$34.2m in net cash and a decent-looking balance sheet. So while Kingsmen Creatives does not have a great balance sheet, it's certainly not too bad. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Kingsmen Creatives (at least 1 which is significant) , and understanding them should be part of your investment process.

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.

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.