Warren Buffett famously said, '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 Zhejiang Hechuan Technology Co., Ltd. (SHSE:688320) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Zhejiang Hechuan Technology Carry?
The image below, which you can click on for greater detail, shows that at September 2023 Zhejiang Hechuan Technology had debt of CN¥203.5m, up from CN¥60.5m in one year. However, its balance sheet shows it holds CN¥268.6m in cash, so it actually has CN¥65.2m net cash.
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How Healthy Is Zhejiang Hechuan Technology's Balance Sheet?
According to the last reported balance sheet, Zhejiang Hechuan Technology had liabilities of CN¥611.0m due within 12 months, and liabilities of CN¥49.8m due beyond 12 months. Offsetting this, it had CN¥268.6m in cash and CN¥748.3m in receivables that were due within 12 months. So it actually has CN¥356.1m more liquid assets than total liabilities.
This surplus suggests that Zhejiang Hechuan Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Zhejiang Hechuan Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Zhejiang Hechuan Technology if management cannot prevent a repeat of the 26% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Zhejiang Hechuan Technology'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Zhejiang Hechuan Technology 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. During the last three years, Zhejiang Hechuan Technology burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Hechuan Technology has net cash of CN¥65.2m, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Zhejiang Hechuan Technology's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Zhejiang Hechuan Technology is showing 1 warning sign in our investment analysis , you should know about...
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.