David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Shenzhen Prince New Materials Co.,Ltd. (SZSE:002735) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Shenzhen Prince New MaterialsLtd Carry?
As you can see below, Shenzhen Prince New MaterialsLtd had CN¥317.3m of debt at September 2024, down from CN¥404.7m a year prior. But on the other hand it also has CN¥573.4m in cash, leading to a CN¥256.2m net cash position.
A Look At Shenzhen Prince New MaterialsLtd's Liabilities
The latest balance sheet data shows that Shenzhen Prince New MaterialsLtd had liabilities of CN¥968.8m due within a year, and liabilities of CN¥42.5m falling due after that. Offsetting this, it had CN¥573.4m in cash and CN¥868.2m in receivables that were due within 12 months. So it actually has CN¥430.4m more liquid assets than total liabilities.
This surplus suggests that Shenzhen Prince New MaterialsLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shenzhen Prince New MaterialsLtd 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 Prince New MaterialsLtd has boosted its EBIT by 31%, 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 future earnings, more than anything, that will determine Shenzhen Prince New MaterialsLtd'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shenzhen Prince New MaterialsLtd 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, Shenzhen Prince New MaterialsLtd 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 Shenzhen Prince New MaterialsLtd has net cash of CN¥256.2m, as well as more liquid assets than liabilities. And we liked the look of last year's 31% year-on-year EBIT growth. So we are not troubled with Shenzhen Prince New MaterialsLtd'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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Shenzhen Prince New MaterialsLtd you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
