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 note that Shenzhen Bluetrum Technology Co., Ltd. (SHSE:688332) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. 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. 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 Shenzhen Bluetrum Technology Carry?
As you can see below, at the end of March 2024, Shenzhen Bluetrum Technology had CN¥1.10b of debt, up from CN¥121.2m a year ago. Click the image for more detail. But it also has CN¥3.97b in cash to offset that, meaning it has CN¥2.87b net cash.
How Healthy Is Shenzhen Bluetrum Technology's Balance Sheet?
We can see from the most recent balance sheet that Shenzhen Bluetrum Technology had liabilities of CN¥1.25b falling due within a year, and liabilities of CN¥2.95m due beyond that. Offsetting these obligations, it had cash of CN¥3.97b as well as receivables valued at CN¥56.5m due within 12 months. So it actually has CN¥2.78b more liquid assets than total liabilities.
This luscious liquidity implies that Shenzhen Bluetrum Technology's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Shenzhen Bluetrum Technology has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Shenzhen Bluetrum Technology grew its EBIT by 62% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shenzhen Bluetrum Technology can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shenzhen Bluetrum 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. Looking at the most recent three years, Shenzhen Bluetrum Technology recorded free cash flow of 22% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Bluetrum Technology has net cash of CN¥2.87b, as well as more liquid assets than liabilities. And we liked the look of last year's 62% year-on-year EBIT growth. So is Shenzhen Bluetrum Technology's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shenzhen Bluetrum Technology (of which 1 is a bit concerning!) you should know about.
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.