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. We can see that Zhejiang Sanhua Intelligent Controls Co.,Ltd (SZSE:002050) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Zhejiang Sanhua Intelligent ControlsLtd
How Much Debt Does Zhejiang Sanhua Intelligent ControlsLtd Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2022 Zhejiang Sanhua Intelligent ControlsLtd had CN¥6.04b of debt, an increase on CN¥2.19b, over one year. However, its balance sheet shows it holds CN¥6.40b in cash, so it actually has CN¥358.0m net cash.SZSE:002050 Debt to Equity History August 1st 2022
How Strong Is Zhejiang Sanhua Intelligent ControlsLtd's Balance Sheet?
The latest balance sheet data shows that Zhejiang Sanhua Intelligent ControlsLtd had liabilities of CN¥8.06b due within a year, and liabilities of CN¥4.53b falling due after that. Offsetting this, it had CN¥6.40b in cash and CN¥6.19b in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
This state of affairs indicates that Zhejiang Sanhua Intelligent ControlsLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥116.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Zhejiang Sanhua Intelligent ControlsLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Zhejiang Sanhua Intelligent ControlsLtd grew its EBIT at 14% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhejiang Sanhua Intelligent ControlsLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Zhejiang Sanhua Intelligent ControlsLtd 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, Zhejiang Sanhua Intelligent ControlsLtd reported free cash flow worth 19% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Zhejiang Sanhua Intelligent ControlsLtd has CN¥358.0m in net cash. And it also grew its EBIT by 14% over the last year. So we are not troubled with Zhejiang Sanhua Intelligent ControlsLtd's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Zhejiang Sanhua Intelligent ControlsLtd (1 doesn't sit too well with us) 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.