Shanghai Automobile Air-Conditioner Accessories (SHSE:603107) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Shanghai Automobile Air-Conditioner Accessories Co., Ltd. (SHSE:603107) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Shanghai Automobile Air-Conditioner Accessories

How Much Debt Does Shanghai Automobile Air-Conditioner Accessories Carry?

You can click the graphic below for the historical numbers, but it shows that Shanghai Automobile Air-Conditioner Accessories had CN¥183.1m of debt in March 2024, down from CN¥259.9m, one year before. However, its balance sheet shows it holds CN¥1.06b in cash, so it actually has CN¥874.4m net cash.

How Healthy Is Shanghai Automobile Air-Conditioner Accessories' Balance Sheet?

We can see from the most recent balance sheet that Shanghai Automobile Air-Conditioner Accessories had liabilities of CN¥552.4m falling due within a year, and liabilities of CN¥167.9m due beyond that. On the other hand, it had cash of CN¥1.06b and CN¥545.1m worth of receivables due within a year. So it actually has CN¥882.2m more liquid assets than total liabilities.

It's good to see that Shanghai Automobile Air-Conditioner Accessories has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Shanghai Automobile Air-Conditioner Accessories has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Shanghai Automobile Air-Conditioner Accessories grew its EBIT by 19% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shanghai Automobile Air-Conditioner Accessories 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Shanghai Automobile Air-Conditioner Accessories 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. Considering the last three years, Shanghai Automobile Air-Conditioner Accessories actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Automobile Air-Conditioner Accessories has net cash of CN¥874.4m, as well as more liquid assets than liabilities. And we liked the look of last year's 19% year-on-year EBIT growth. So we are not troubled with Shanghai Automobile Air-Conditioner Accessories's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Shanghai Automobile Air-Conditioner Accessories , and understanding them should be part of your investment process.

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.

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.