Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Xuzhou Handler Special Vehicle Co., Ltd (SZSE:300201) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Xuzhou Handler Special Vehicle

What Is Xuzhou Handler Special Vehicle's Debt?

As you can see below, at the end of September 2023, Xuzhou Handler Special Vehicle had CN¥201.0m of debt, up from CN¥146.6m a year ago. Click the image for more detail. However, it does have CN¥80.3m in cash offsetting this, leading to net debt of about CN¥120.8m.

How Strong Is Xuzhou Handler Special Vehicle's Balance Sheet?

The latest balance sheet data shows that Xuzhou Handler Special Vehicle had liabilities of CN¥959.1m due within a year, and liabilities of CN¥50.1m falling due after that. On the other hand, it had cash of CN¥80.3m and CN¥1.12b worth of receivables due within a year. So it can boast CN¥194.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Xuzhou Handler Special Vehicle could probably pay off its debt with ease, as its balance sheet is far from stretched.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Xuzhou Handler Special Vehicle has a low net debt to EBITDA ratio of only 0.59. And its EBIT covers its interest expense a whopping 29.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Xuzhou Handler Special Vehicle's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of 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 Xuzhou Handler Special Vehicle can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent two years, Xuzhou Handler Special Vehicle recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that Xuzhou Handler Special Vehicle's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think Xuzhou Handler Special Vehicle's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in Xuzhou Handler Special Vehicle, you may well want to click here to check an interactive graph of its earnings per share history.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.