These 4 Measures Indicate That Xuchang Yuandong Drive ShaftLtd (SZSE:002406) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Xuchang Yuandong Drive Shaft Co.Ltd (SZSE:002406) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Xuchang Yuandong Drive ShaftLtd

What Is Xuchang Yuandong Drive ShaftLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Xuchang Yuandong Drive ShaftLtd had CN¥15.5m of debt in September 2024, down from CN¥300.0m, one year before. But on the other hand it also has CN¥1.21b in cash, leading to a CN¥1.20b net cash position.

A Look At Xuchang Yuandong Drive ShaftLtd's Liabilities

According to the last reported balance sheet, Xuchang Yuandong Drive ShaftLtd had liabilities of CN¥629.2m due within 12 months, and liabilities of CN¥170.4m due beyond 12 months. On the other hand, it had cash of CN¥1.21b and CN¥829.9m worth of receivables due within a year. So it can boast CN¥1.24b more liquid assets than total liabilities.

This excess liquidity suggests that Xuchang Yuandong Drive ShaftLtd is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Xuchang Yuandong Drive ShaftLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Xuchang Yuandong Drive ShaftLtd grew its EBIT at 19% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Xuchang Yuandong Drive ShaftLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Xuchang Yuandong Drive ShaftLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Xuchang Yuandong Drive ShaftLtd produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Xuchang Yuandong Drive ShaftLtd has CN¥1.20b in net cash and a decent-looking balance sheet. And we liked the look of last year's 19% year-on-year EBIT growth. So is Xuchang Yuandong Drive ShaftLtd's debt a risk? It doesn't seem so to us. 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. For example Xuchang Yuandong Drive ShaftLtd has 3 warning signs (and 1 which is potentially serious) we think 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.