The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Wuxi Boton Technology Co., Ltd. (SZSE:300031) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Wuxi Boton Technology Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2024 Wuxi Boton Technology had CN¥833.2m of debt, an increase on CN¥561.6m, over one year. However, it does have CN¥1.34b in cash offsetting this, leading to net cash of CN¥505.2m.
How Strong Is Wuxi Boton Technology's Balance Sheet?
We can see from the most recent balance sheet that Wuxi Boton Technology had liabilities of CN¥1.74b falling due within a year, and liabilities of CN¥254.8m due beyond that. On the other hand, it had cash of CN¥1.34b and CN¥978.1m worth of receivables due within a year. So it can boast CN¥318.9m more liquid assets than total liabilities.
This surplus suggests that Wuxi Boton Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Wuxi Boton Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Wuxi Boton Technology grew its EBIT by 332% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Wuxi Boton Technology 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Wuxi Boton 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. Over the last three years, Wuxi Boton Technology reported free cash flow worth 8.0% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
Summing Up
While it is always sensible to investigate a company's debt, in this case Wuxi Boton Technology has CN¥505.2m in net cash and a decent-looking balance sheet. And we liked the look of last year's 332% year-on-year EBIT growth. So is Wuxi Boton 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. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Wuxi Boton Technology that 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.
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