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.' 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. Importantly, Sichuan Shudao Equipment & Technology Co.,Ltd. (SZSE:300540) does carry debt. 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. 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. 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 Sichuan Shudao Equipment & TechnologyLtd's Debt?
The image below, which you can click on for greater detail, shows that at June 2024 Sichuan Shudao Equipment & TechnologyLtd had debt of CN¥107.1m, up from CN¥101.0m in one year. However, its balance sheet shows it holds CN¥144.4m in cash, so it actually has CN¥37.3m net cash.
How Healthy Is Sichuan Shudao Equipment & TechnologyLtd's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Sichuan Shudao Equipment & TechnologyLtd had liabilities of CN¥625.0m due within 12 months and liabilities of CN¥8.47m due beyond that. Offsetting these obligations, it had cash of CN¥144.4m as well as receivables valued at CN¥532.0m due within 12 months. So it actually has CN¥42.9m more liquid assets than total liabilities.
This state of affairs indicates that Sichuan Shudao Equipment & TechnologyLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥3.80b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Sichuan Shudao Equipment & TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Sichuan Shudao Equipment & TechnologyLtd made a loss at the EBIT level, last year, it was also good to see that it generated CN¥25m in EBIT over the last twelve months. 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 Sichuan Shudao Equipment & TechnologyLtd'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 company can only pay off debt with cold hard cash, not accounting profits. While Sichuan Shudao Equipment & TechnologyLtd 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 year, Sichuan Shudao Equipment & TechnologyLtd saw substantial negative free cash flow, in total. 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 Sichuan Shudao Equipment & TechnologyLtd has net cash of CN¥37.3m, as well as more liquid assets than liabilities. So we don't have any problem with Sichuan Shudao Equipment & TechnologyLtd's use of debt. 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. Case in point: We've spotted 1 warning sign for Sichuan Shudao Equipment & TechnologyLtd you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
