Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk'. 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 Activation Group Holdings Limited (HKG:9919) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Activation Group Holdings

What Is Activation Group Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2019 Activation Group Holdings had CN¥74.8m of debt, an increase on CN¥19.0m, over one year. But it also has CN¥131.1m in cash to offset that, meaning it has CN¥56.3m net cash.

How Healthy Is Activation Group Holdings's Balance Sheet?

The latest balance sheet data shows that Activation Group Holdings had liabilities of CN¥274.2m due within a year, and liabilities of CN¥13.5m falling due after that. On the other hand, it had cash of CN¥131.1m and CN¥170.3m worth of receivables due within a year. So it actually has CN¥13.8m more liquid assets than total liabilities.

This surplus suggests that Activation Group Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Activation Group Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Activation Group Holdings has seen its EBIT plunge 15% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is Activation Group Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.