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 Shanghai Feilo Acoustics Co.,Ltd (SHSE:600651) makes use of debt. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.
Check out our latest analysis for Shanghai Feilo AcousticsLtd
What Is Shanghai Feilo AcousticsLtd's Debt?
As you can see below, Shanghai Feilo AcousticsLtd had CN¥917.5m of debt at September 2023, down from CN¥1.21b a year prior. However, it does have CN¥1.05b in cash offsetting this, leading to net cash of CN¥135.5m.
How Strong Is Shanghai Feilo AcousticsLtd's Balance Sheet?
According to the last reported balance sheet, Shanghai Feilo AcousticsLtd had liabilities of CN¥1.02b due within 12 months, and liabilities of CN¥763.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.05b as well as receivables valued at CN¥828.1m due within 12 months. So it actually has CN¥96.9m more liquid assets than total liabilities.
Having regard to Shanghai Feilo AcousticsLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥8.70b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Shanghai Feilo AcousticsLtd has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shanghai Feilo AcousticsLtd 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.
In the last year Shanghai Feilo AcousticsLtd had a loss before interest and tax, and actually shrunk its revenue by 61%, to CN¥2.0b. To be frank that doesn't bode well.
So How Risky Is Shanghai Feilo AcousticsLtd?
Although Shanghai Feilo AcousticsLtd had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of CN¥12m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. 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. For example, we've discovered 1 warning sign for Shanghai Feilo AcousticsLtd that you should be aware of before investing here.
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.