Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Zhejiang RIFA Precision Machinery Co., Ltd. (SZSE:002520) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Zhejiang RIFA Precision Machinery's Debt?
As you can see below, Zhejiang RIFA Precision Machinery had CN¥1.60b of debt at September 2023, down from CN¥1.94b a year prior. However, it also had CN¥273.6m in cash, and so its net debt is CN¥1.32b.
A Look At Zhejiang RIFA Precision Machinery's Liabilities
According to the last reported balance sheet, Zhejiang RIFA Precision Machinery had liabilities of CN¥1.99b due within 12 months, and liabilities of CN¥1.01b due beyond 12 months. Offsetting this, it had CN¥273.6m in cash and CN¥536.4m in receivables that were due within 12 months. So it has liabilities totalling CN¥2.20b more than its cash and near-term receivables, combined.
Zhejiang RIFA Precision Machinery has a market capitalization of CN¥3.82b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Zhejiang RIFA Precision Machinery will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Zhejiang RIFA Precision Machinery made a loss at the EBIT level, and saw its revenue drop to CN¥2.1b, which is a fall of 5.6%. We would much prefer see growth.
Caveat Emptor
Importantly, Zhejiang RIFA Precision Machinery had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥17m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥48m of cash over the last year. So to be blunt we think it is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Zhejiang RIFA Precision Machinery (of which 2 are a bit unpleasant!) you should know about.
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.
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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.