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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Huada Automotive Technology Corp.,Ltd (SHSE:603358) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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.

How Much Debt Does Huada Automotive TechnologyLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Huada Automotive TechnologyLtd had CN¥540.6m of debt, an increase on CN¥382.6m, over one year. However, its balance sheet shows it holds CN¥1.06b in cash, so it actually has CN¥516.1m net cash.

A Look At Huada Automotive TechnologyLtd's Liabilities

The latest balance sheet data shows that Huada Automotive TechnologyLtd had liabilities of CN¥2.44b due within a year, and liabilities of CN¥400.0m falling due after that. Offsetting these obligations, it had cash of CN¥1.06b as well as receivables valued at CN¥1.46b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥320.9m.

Of course, Huada Automotive TechnologyLtd has a market capitalization of CN¥12.5b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Huada Automotive TechnologyLtd 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 Huada Automotive TechnologyLtd has boosted its EBIT by 34%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Huada Automotive TechnologyLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Huada Automotive TechnologyLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Huada Automotive TechnologyLtd created free cash flow amounting to 14% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

We could understand if investors are concerned about Huada Automotive TechnologyLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥516.1m. And it impressed us with its EBIT growth of 34% over the last year. So we don't think Huada Automotive TechnologyLtd's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Huada Automotive TechnologyLtd you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

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