Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Jiangsu Olive Sensors High-Tech Co., Ltd. (SZSE:300507) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
What Is Jiangsu Olive Sensors High-Tech's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2024 Jiangsu Olive Sensors High-Tech had CN¥513.0m of debt, an increase on CN¥339.0m, over one year. However, its balance sheet shows it holds CN¥746.4m in cash, so it actually has CN¥233.3m net cash.
A Look At Jiangsu Olive Sensors High-Tech's Liabilities
We can see from the most recent balance sheet that Jiangsu Olive Sensors High-Tech had liabilities of CN¥693.4m falling due within a year, and liabilities of CN¥185.6m due beyond that. On the other hand, it had cash of CN¥746.4m and CN¥598.4m worth of receivables due within a year. So it can boast CN¥465.7m more liquid assets than total liabilities.
This surplus suggests that Jiangsu Olive Sensors High-Tech has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Jiangsu Olive Sensors High-Tech has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Jiangsu Olive Sensors High-Tech has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Jiangsu Olive Sensors High-Tech's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Jiangsu Olive Sensors High-Tech 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, Jiangsu Olive Sensors High-Tech 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 Jiangsu Olive Sensors High-Tech has net cash of CN¥233.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 39% over the last year. So we are not troubled with Jiangsu Olive Sensors High-Tech's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Jiangsu Olive Sensors High-Tech has 3 warning signs (and 1 which is significant) we think 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com