Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Hoymiles Power Electronics Inc. (SHSE:688032) 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?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

What Is Hoymiles Power Electronics's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Hoymiles Power Electronics had debt of CN¥131.0m, up from none in one year. However, it does have CN¥4.42b in cash offsetting this, leading to net cash of CN¥4.29b.

How Strong Is Hoymiles Power Electronics' Balance Sheet?

The latest balance sheet data shows that Hoymiles Power Electronics had liabilities of CN¥1.34b due within a year, and liabilities of CN¥109.9m falling due after that. On the other hand, it had cash of CN¥4.42b and CN¥685.1m worth of receivables due within a year. So it actually has CN¥3.65b more liquid assets than total liabilities.

This excess liquidity suggests that Hoymiles Power Electronics is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Hoymiles Power Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Hoymiles Power Electronics's load is not too heavy, because its EBIT was down 55% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hoymiles Power Electronics'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hoymiles Power Electronics 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 last three years, Hoymiles Power Electronics saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hoymiles Power Electronics has CN¥4.29b in net cash and a decent-looking balance sheet. So we are not troubled with Hoymiles Power Electronics's debt use. 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 3 warning signs for Hoymiles Power Electronics (2 are significant) 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.

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.