David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Shenzhen Hui Chuang Da Technology Co., Ltd. (SZSE:300909) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Shenzhen Hui Chuang Da Technology's Net Debt?
As you can see below, Shenzhen Hui Chuang Da Technology had CN¥32.5m of debt at March 2024, down from CN¥110.3m a year prior. However, its balance sheet shows it holds CN¥616.5m in cash, so it actually has CN¥584.0m net cash.
A Look At Shenzhen Hui Chuang Da Technology's Liabilities
The latest balance sheet data shows that Shenzhen Hui Chuang Da Technology had liabilities of CN¥485.5m due within a year, and liabilities of CN¥227.3m falling due after that. Offsetting this, it had CN¥616.5m in cash and CN¥474.6m in receivables that were due within 12 months. So it actually has CN¥378.3m more liquid assets than total liabilities.
This surplus suggests that Shenzhen Hui Chuang Da Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shenzhen Hui Chuang Da Technology 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 Shenzhen Hui Chuang Da Technology has boosted its EBIT by 46%, 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 Shenzhen Hui Chuang Da Technology will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Shenzhen Hui Chuang Da Technology 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. Considering the last three years, Shenzhen Hui Chuang Da Technology actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Summing Up
While it is always sensible to investigate a company's debt, in this case Shenzhen Hui Chuang Da Technology has CN¥584.0m in net cash and a decent-looking balance sheet. And we liked the look of last year's 46% year-on-year EBIT growth. So is Shenzhen Hui Chuang Da Technology's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Shenzhen Hui Chuang Da Technology has 4 warning signs we think you should be aware of.
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.
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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.