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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Shanghai Hanbell Precise Machinery Co., Ltd. (SZSE:002158) does carry debt. 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Shanghai Hanbell Precise Machinery Carry?
As you can see below, Shanghai Hanbell Precise Machinery had CN¥940.6m of debt at June 2024, down from CN¥1.04b a year prior. But it also has CN¥2.24b in cash to offset that, meaning it has CN¥1.30b net cash.
How Healthy Is Shanghai Hanbell Precise Machinery's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Shanghai Hanbell Precise Machinery had liabilities of CN¥2.25b due within 12 months and liabilities of CN¥191.4m due beyond that. Offsetting this, it had CN¥2.24b in cash and CN¥1.04b in receivables that were due within 12 months. So it can boast CN¥841.1m more liquid assets than total liabilities.
This surplus suggests that Shanghai Hanbell Precise Machinery has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shanghai Hanbell Precise Machinery boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, Shanghai Hanbell Precise Machinery grew its EBIT by 22% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shanghai Hanbell Precise Machinery'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Shanghai Hanbell Precise Machinery has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Shanghai Hanbell Precise Machinery recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While it is always sensible to investigate a company's debt, in this case Shanghai Hanbell Precise Machinery has CN¥1.30b in net cash and a decent-looking balance sheet. And we liked the look of last year's 22% year-on-year EBIT growth. So we don't think Shanghai Hanbell Precise Machinery's use of debt is risky. 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 example - Shanghai Hanbell Precise Machinery has 1 warning sign we think 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.
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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.