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 Shenzhen Microgate Technology Co., Ltd. (SZSE:300319) does have debt on its balance sheet. 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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Shenzhen Microgate Technology Carry?
As you can see below, at the end of June 2024, Shenzhen Microgate Technology had CN¥184.8m of debt, up from CN¥3.37m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.32b in cash, so it actually has CN¥1.14b net cash.
A Look At Shenzhen Microgate Technology's Liabilities
We can see from the most recent balance sheet that Shenzhen Microgate Technology had liabilities of CN¥1.54b falling due within a year, and liabilities of CN¥255.8m due beyond that. On the other hand, it had cash of CN¥1.32b and CN¥1.15b worth of receivables due within a year. So it actually has CN¥680.4m more liquid assets than total liabilities.
This short term liquidity is a sign that Shenzhen Microgate Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shenzhen Microgate Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Shenzhen Microgate Technology has boosted its EBIT by 53%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shenzhen Microgate Technology's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shenzhen Microgate 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. Happily for any shareholders, Shenzhen Microgate Technology actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing Up
While it is always sensible to investigate a company's debt, in this case Shenzhen Microgate Technology has CN¥1.14b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥23m, being 106% of its EBIT. So we don't think Shenzhen Microgate Technology's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Shenzhen Microgate Technology that you should be aware of.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
