These 4 Measures Indicate That Wuxi Longsheng TechnologyLtd (SZSE:300680) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Wuxi Longsheng Technology Co.,Ltd (SZSE:300680) makes use of debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Wuxi Longsheng TechnologyLtd

How Much Debt Does Wuxi Longsheng TechnologyLtd Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Wuxi Longsheng TechnologyLtd had debt of CN¥1.22b, up from CN¥935.9m in one year. However, it also had CN¥672.0m in cash, and so its net debt is CN¥552.3m.

A Look At Wuxi Longsheng TechnologyLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Wuxi Longsheng TechnologyLtd had liabilities of CN¥1.61b due within 12 months and liabilities of CN¥311.4m due beyond that. Offsetting this, it had CN¥672.0m in cash and CN¥827.6m in receivables that were due within 12 months. So it has liabilities totalling CN¥420.8m more than its cash and near-term receivables, combined.

Of course, Wuxi Longsheng TechnologyLtd has a market capitalization of CN¥9.44b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

We'd say that Wuxi Longsheng TechnologyLtd's moderate net debt to EBITDA ratio ( being 1.8), indicates prudence when it comes to debt. And its commanding EBIT of 13.2 times its interest expense, implies the debt load is as light as a peacock feather. Pleasingly, Wuxi Longsheng TechnologyLtd is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 104% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Wuxi Longsheng TechnologyLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Wuxi Longsheng TechnologyLtd 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.

Our View

Wuxi Longsheng TechnologyLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that Wuxi Longsheng TechnologyLtd can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Wuxi Longsheng TechnologyLtd has 1 warning sign we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.