Zhejiang Songyuan Automotive Safety SystemsLtd (SZSE:300893) 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 Zhejiang Songyuan Automotive Safety Systems Co.,Ltd. (SZSE:300893) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Zhejiang Songyuan Automotive Safety SystemsLtd

How Much Debt Does Zhejiang Songyuan Automotive Safety SystemsLtd Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Zhejiang Songyuan Automotive Safety SystemsLtd had debt of CN¥748.1m, up from CN¥390.6m in one year. On the flip side, it has CN¥166.3m in cash leading to net debt of about CN¥581.8m.

A Look At Zhejiang Songyuan Automotive Safety SystemsLtd's Liabilities

We can see from the most recent balance sheet that Zhejiang Songyuan Automotive Safety SystemsLtd had liabilities of CN¥664.8m falling due within a year, and liabilities of CN¥496.5m due beyond that. On the other hand, it had cash of CN¥166.3m and CN¥757.0m worth of receivables due within a year. So it has liabilities totalling CN¥238.0m more than its cash and near-term receivables, combined.

Since publicly traded Zhejiang Songyuan Automotive Safety SystemsLtd shares are worth a total of CN¥6.27b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Zhejiang Songyuan Automotive Safety SystemsLtd's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its strong interest cover of 34.9 times, makes us even more comfortable. In addition to that, we're happy to report that Zhejiang Songyuan Automotive Safety SystemsLtd has boosted its EBIT by 98%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Zhejiang Songyuan Automotive Safety SystemsLtd's ability to maintain a healthy balance sheet going forward. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Zhejiang Songyuan Automotive Safety SystemsLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Zhejiang Songyuan Automotive Safety SystemsLtd'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. All these things considered, it appears that Zhejiang Songyuan Automotive Safety SystemsLtd can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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 2 warning signs with Zhejiang Songyuan Automotive Safety SystemsLtd (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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.