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.' 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 Bichamp Cutting Technology (Hunan) Co., Ltd. (SZSE:002843) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Bichamp Cutting Technology (Hunan) Carry?
The image below, which you can click on for greater detail, shows that Bichamp Cutting Technology (Hunan) had debt of CN¥342.2m at the end of December 2023, a reduction from CN¥365.9m over a year. However, its balance sheet shows it holds CN¥712.5m in cash, so it actually has CN¥370.3m net cash.
How Healthy Is Bichamp Cutting Technology (Hunan)'s Balance Sheet?
According to the last reported balance sheet, Bichamp Cutting Technology (Hunan) had liabilities of CN¥939.6m due within 12 months, and liabilities of CN¥254.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥712.5m as well as receivables valued at CN¥612.8m due within 12 months. So it actually has CN¥131.4m more liquid assets than total liabilities.
This surplus suggests that Bichamp Cutting Technology (Hunan) has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Bichamp Cutting Technology (Hunan) has more cash than debt is arguably a good indication that it can manage its debt safely.
But the bad news is that Bichamp Cutting Technology (Hunan) has seen its EBIT plunge 12% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Bichamp Cutting Technology (Hunan) can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Bichamp Cutting Technology (Hunan) 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 most recent three years, Bichamp Cutting Technology (Hunan) recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
While it is always sensible to investigate a company's debt, in this case Bichamp Cutting Technology (Hunan) has CN¥370.3m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of -CN¥34m, being 74% of its EBIT. So we don't have any problem with Bichamp Cutting Technology (Hunan)'s use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Bichamp Cutting Technology (Hunan) you should know about.
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.
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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.