These 4 Measures Indicate That Zhejiang Taotao Vehicles (SZSE:301345) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Zhejiang Taotao Vehicles Co., Ltd. (SZSE:301345) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

See our latest analysis for Zhejiang Taotao Vehicles

How Much Debt Does Zhejiang Taotao Vehicles Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Zhejiang Taotao Vehicles had debt of CN¥551.4m, up from CN¥479.0m in one year. But it also has CN¥1.71b in cash to offset that, meaning it has CN¥1.16b net cash.

How Healthy Is Zhejiang Taotao Vehicles' Balance Sheet?

The latest balance sheet data shows that Zhejiang Taotao Vehicles had liabilities of CN¥1.40b due within a year, and liabilities of CN¥88.5m falling due after that. Offsetting these obligations, it had cash of CN¥1.71b as well as receivables valued at CN¥614.7m due within 12 months. So it actually has CN¥835.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Zhejiang Taotao Vehicles could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Zhejiang Taotao Vehicles has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Zhejiang Taotao Vehicles has boosted its EBIT by 74%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Zhejiang Taotao Vehicles'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. While Zhejiang Taotao Vehicles has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Zhejiang Taotao Vehicles recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Taotao Vehicles has CN¥1.16b in net cash and a decent-looking balance sheet. And we liked the look of last year's 74% year-on-year EBIT growth. So we don't have any problem with Zhejiang Taotao Vehicles's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Zhejiang Taotao Vehicles (of which 1 is a bit concerning!) you should know about.

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.

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.