Sinoma International EngineeringLtd (SHSE:600970) Seems To Use Debt Quite Sensibly

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.' 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. As with many other companies Sinoma International Engineering Co.,Ltd (SHSE:600970) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Sinoma International EngineeringLtd

What Is Sinoma International EngineeringLtd's Debt?

The image below, which you can click on for greater detail, shows that Sinoma International EngineeringLtd had debt of CN¥6.17b at the end of September 2024, a reduction from CN¥7.38b over a year. But it also has CN¥6.34b in cash to offset that, meaning it has CN¥164.8m net cash.

How Strong Is Sinoma International EngineeringLtd's Balance Sheet?

We can see from the most recent balance sheet that Sinoma International EngineeringLtd had liabilities of CN¥29.4b falling due within a year, and liabilities of CN¥4.62b due beyond that. Offsetting this, it had CN¥6.34b in cash and CN¥22.6b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.14b.

Of course, Sinoma International EngineeringLtd has a market capitalization of CN¥26.0b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Sinoma International EngineeringLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Sinoma International EngineeringLtd grew its EBIT by 14% last year, making its debt load easier to handle. 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 Sinoma International EngineeringLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Sinoma International EngineeringLtd 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. Looking at the most recent three years, Sinoma International EngineeringLtd recorded free cash flow of 42% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While Sinoma International EngineeringLtd does have more liabilities than liquid assets, it also has net cash of CN¥164.8m. On top of that, it increased its EBIT by 14% in the last twelve months. So we don't have any problem with Sinoma International EngineeringLtd's use of debt. 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. For instance, we've identified 1 warning sign for Sinoma International EngineeringLtd that 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.