Essence Fastening Systems (Shanghai) (SZSE:301005) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Essence Fastening Systems (Shanghai) Co., Ltd. (SZSE:301005) makes use of debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Essence Fastening Systems (Shanghai)

What Is Essence Fastening Systems (Shanghai)'s Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Essence Fastening Systems (Shanghai) had debt of CN¥145.0m, up from CN¥93.1m in one year. However, it does have CN¥190.2m in cash offsetting this, leading to net cash of CN¥45.1m.

How Healthy Is Essence Fastening Systems (Shanghai)'s Balance Sheet?

We can see from the most recent balance sheet that Essence Fastening Systems (Shanghai) had liabilities of CN¥371.4m falling due within a year, and liabilities of CN¥24.0m due beyond that. Offsetting this, it had CN¥190.2m in cash and CN¥239.4m in receivables that were due within 12 months. So it can boast CN¥34.1m more liquid assets than total liabilities.

This state of affairs indicates that Essence Fastening Systems (Shanghai)'s balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥4.56b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Essence Fastening Systems (Shanghai) has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Essence Fastening Systems (Shanghai)'s load is not too heavy, because its EBIT was down 89% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Essence Fastening Systems (Shanghai) 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Essence Fastening Systems (Shanghai) 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, Essence Fastening Systems (Shanghai) burned a lot of cash. 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case Essence Fastening Systems (Shanghai) has CN¥45.1m in net cash and a decent-looking balance sheet. So while Essence Fastening Systems (Shanghai) does not have a great balance sheet, it's certainly not too bad. 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. For instance, we've identified 4 warning signs for Essence Fastening Systems (Shanghai) (1 is concerning) you should be aware of.

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.

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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.