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. We can see that Shenzhen Topband Co., Ltd. (SZSE:002139) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Shenzhen Topband's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Shenzhen Topband had CN¥1.34b of debt, an increase on CN¥1.07b, over one year. However, it does have CN¥2.42b in cash offsetting this, leading to net cash of CN¥1.08b.
A Look At Shenzhen Topband's Liabilities
Zooming in on the latest balance sheet data, we can see that Shenzhen Topband had liabilities of CN¥3.85b due within 12 months and liabilities of CN¥1.01b due beyond that. Offsetting this, it had CN¥2.42b in cash and CN¥2.59b in receivables that were due within 12 months. So it can boast CN¥155.7m more liquid assets than total liabilities.
This state of affairs indicates that Shenzhen Topband's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥11.0b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Shenzhen Topband has more cash than debt is arguably a good indication that it can manage its debt safely.
Even more impressive was the fact that Shenzhen Topband grew its EBIT by 169% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Shenzhen Topband 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, a company can only pay off debt with cold hard cash, not accounting profits. While Shenzhen Topband 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 Topband saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Summing Up
While it is always sensible to investigate a company's debt, in this case Shenzhen Topband has CN¥1.08b in net cash and a decent-looking balance sheet. And we liked the look of last year's 169% year-on-year EBIT growth. So we don't have any problem with Shenzhen Topband's use of debt. 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. Be aware that Shenzhen Topband is showing 1 warning sign in our investment analysis , you should know about...
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.