Anhui Anfu Battery TechnologyLtd (SHSE:603031) Has A Pretty Healthy Balance Sheet

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Anhui Anfu Battery Technology Co.,Ltd (SHSE:603031) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Anhui Anfu Battery TechnologyLtd

How Much Debt Does Anhui Anfu Battery TechnologyLtd Carry?

The image below, which you can click on for greater detail, shows that Anhui Anfu Battery TechnologyLtd had debt of CN¥2.01b at the end of June 2024, a reduction from CN¥2.42b over a year. However, because it has a cash reserve of CN¥734.4m, its net debt is less, at about CN¥1.27b.

How Strong Is Anhui Anfu Battery TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Anhui Anfu Battery TechnologyLtd had liabilities of CN¥2.07b due within 12 months, and liabilities of CN¥713.9m due beyond 12 months. On the other hand, it had cash of CN¥734.4m and CN¥348.1m worth of receivables due within a year. So it has liabilities totalling CN¥1.70b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Anhui Anfu Battery TechnologyLtd has a market capitalization of CN¥5.80b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Anhui Anfu Battery TechnologyLtd has a low net debt to EBITDA ratio of only 1.2. And its EBIT easily covers its interest expense, being 17.7 times the size. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Anhui Anfu Battery TechnologyLtd grew its EBIT by 11% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Anhui Anfu Battery TechnologyLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Anhui Anfu Battery TechnologyLtd actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Anhui Anfu Battery TechnologyLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Zooming out, Anhui Anfu Battery TechnologyLtd seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. For example - Anhui Anfu Battery TechnologyLtd has 2 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.