Here's Why Beijing WKW Automotive PartsLtd (SZSE:002662) Can Manage Its Debt Responsibly

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.' 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. We can see that Beijing WKW Automotive Parts Co.,Ltd. (SZSE:002662) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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, 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.

View our latest analysis for Beijing WKW Automotive PartsLtd

What Is Beijing WKW Automotive PartsLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Beijing WKW Automotive PartsLtd had CN¥400.3m of debt in September 2023, down from CN¥485.3m, one year before. However, it also had CN¥391.7m in cash, and so its net debt is CN¥8.60m.

How Strong Is Beijing WKW Automotive PartsLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Beijing WKW Automotive PartsLtd had liabilities of CN¥1.03b due within 12 months and liabilities of CN¥40.1m due beyond that. Offsetting this, it had CN¥391.7m in cash and CN¥1.02b in receivables that were due within 12 months. So it actually has CN¥342.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Beijing WKW Automotive PartsLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. But either way, Beijing WKW Automotive PartsLtd has virtually no net debt, so it's fair to say it does not have a heavy debt load!

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Beijing WKW Automotive PartsLtd has barely any net debt, as demonstrated by its net debt to EBITDA ratio of only 0.012. Humorously, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like an Olympic ice-skater handles a pirouette. The good news is that Beijing WKW Automotive PartsLtd has increased its EBIT by 8.0% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Beijing WKW Automotive PartsLtd's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Beijing WKW Automotive PartsLtd recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Beijing WKW Automotive PartsLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Looking at the bigger picture, we think Beijing WKW Automotive PartsLtd's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. We've identified 1 warning sign with Beijing WKW Automotive PartsLtd , and understanding them should be part of your investment process.

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.

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.