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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Essence Fastening Systems (Shanghai) Co., Ltd. (SZSE:301005) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Essence Fastening Systems (Shanghai)

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

As you can see below, at the end of September 2024, Essence Fastening Systems (Shanghai) had CN¥145.0m of debt, up from CN¥93.1m a year ago. Click the image for more detail. But it also has CN¥190.2m in cash to offset that, meaning it has CN¥45.1m net cash.

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

Zooming in on the latest balance sheet data, we can see that Essence Fastening Systems (Shanghai) had liabilities of CN¥371.4m due within 12 months and liabilities of CN¥24.0m due beyond that. Offsetting these obligations, it had cash of CN¥190.2m as well as receivables valued at CN¥239.4m due within 12 months. So it can boast CN¥34.1m more liquid assets than total liabilities.

Having regard to Essence Fastening Systems (Shanghai)'s size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥5.16b 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. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Essence Fastening Systems (Shanghai) 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. 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 we empathize with investors who find debt concerning, you should keep in mind that Essence Fastening Systems (Shanghai) has net cash of CN¥45.1m, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Essence Fastening Systems (Shanghai)'s balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Essence Fastening Systems (Shanghai) (at least 1 which is significant) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.