We Think China Automotive Engineering Research Institute (SHSE:601965) Can Manage Its Debt With Ease

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies China Automotive Engineering Research Institute Co., Ltd. (SHSE:601965) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for China Automotive Engineering Research Institute

How Much Debt Does China Automotive Engineering Research Institute Carry?

As you can see below, at the end of September 2023, China Automotive Engineering Research Institute had CN¥50.8m of debt, up from CN¥10.5m a year ago. Click the image for more detail. But on the other hand it also has CN¥1.58b in cash, leading to a CN¥1.53b net cash position.

How Strong Is China Automotive Engineering Research Institute's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Automotive Engineering Research Institute had liabilities of CN¥1.39b due within 12 months and liabilities of CN¥287.7m due beyond that. Offsetting these obligations, it had cash of CN¥1.58b as well as receivables valued at CN¥1.88b due within 12 months. So it actually has CN¥1.78b more liquid assets than total liabilities.

This surplus suggests that China Automotive Engineering Research Institute has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, China Automotive Engineering Research Institute boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, China Automotive Engineering Research Institute grew its EBIT by 29% in the last year, and that should make it easier to pay down debt, going forward. 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 China Automotive Engineering Research Institute 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While China Automotive Engineering Research Institute 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. Looking at the most recent three years, China Automotive Engineering Research Institute recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Automotive Engineering Research Institute has CN¥1.53b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 29% over the last year. So we don't think China Automotive Engineering Research Institute's use of debt is risky. 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 example - China Automotive Engineering Research Institute has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.