These 4 Measures Indicate That NARI Technology (SHSE:600406) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that NARI Technology Co., Ltd. (SHSE:600406) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for NARI Technology

What Is NARI Technology's Debt?

As you can see below, at the end of September 2024, NARI Technology had CN¥642.8m of debt, up from CN¥500.5m a year ago. Click the image for more detail. But it also has CN¥17.8b in cash to offset that, meaning it has CN¥17.1b net cash.

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A Look At NARI Technology's Liabilities

According to the last reported balance sheet, NARI Technology had liabilities of CN¥33.8b due within 12 months, and liabilities of CN¥750.4m due beyond 12 months. Offsetting this, it had CN¥17.8b in cash and CN¥33.3b in receivables that were due within 12 months. So it actually has CN¥16.5b more liquid assets than total liabilities.

This surplus suggests that NARI Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that NARI Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, NARI Technology grew its EBIT by 5.7% in the last year, making that debt load look even more manageable. 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 NARI Technology can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While NARI Technology 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. During the last three years, NARI Technology generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case NARI Technology has CN¥17.1b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥9.5b, being 93% of its EBIT. So is NARI Technology's debt a risk? It doesn't seem so to us. 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 1 warning sign with NARI Technology , 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.