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. We note that New Focus Auto Tech Holdings Limited (HKG:360) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 New Focus Auto Tech Holdings
How Much Debt Does New Focus Auto Tech Holdings Carry?
You can click the graphic below for the historical numbers, but it shows that New Focus Auto Tech Holdings had CN¥272.5m of debt in June 2023, down from CN¥381.7m, one year before. But it also has CN¥1.10b in cash to offset that, meaning it has CN¥823.7m net cash.
How Healthy Is New Focus Auto Tech Holdings' Balance Sheet?
The latest balance sheet data shows that New Focus Auto Tech Holdings had liabilities of CN¥701.5m due within a year, and liabilities of CN¥42.1m falling due after that. Offsetting these obligations, it had cash of CN¥1.10b as well as receivables valued at CN¥94.4m due within 12 months. So it can boast CN¥447.1m more liquid assets than total liabilities.
This surplus suggests that New Focus Auto Tech Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that New Focus Auto Tech Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is New Focus Auto Tech Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year New Focus Auto Tech Holdings's revenue was pretty flat, and it made a negative EBIT. While that's not too bad, we'd prefer see growth.
So How Risky Is New Focus Auto Tech Holdings?
Statistically speaking companies that lose money are riskier than those that make money. And in the last year New Focus Auto Tech Holdings had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of CN¥42m and booked a CN¥36m accounting loss. Given it only has net cash of CN¥823.7m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with New Focus Auto Tech Holdings .
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.