These 4 Measures Indicate That Zhejiang Rongtai Electric MaterialLtd (SHSE:603119) Is Using Debt Safely

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Rongtai Electric Material Co.,Ltd. (SHSE:603119) 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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Zhejiang Rongtai Electric MaterialLtd

What Is Zhejiang Rongtai Electric MaterialLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zhejiang Rongtai Electric MaterialLtd had CN¥21.9m of debt in March 2024, down from CN¥202.2m, one year before. However, its balance sheet shows it holds CN¥999.6m in cash, so it actually has CN¥977.7m net cash.

How Healthy Is Zhejiang Rongtai Electric MaterialLtd's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Rongtai Electric MaterialLtd had liabilities of CN¥235.3m falling due within a year, and liabilities of CN¥38.4m due beyond that. Offsetting these obligations, it had cash of CN¥999.6m as well as receivables valued at CN¥256.9m due within 12 months. So it can boast CN¥982.7m more liquid assets than total liabilities.

It's good to see that Zhejiang Rongtai Electric MaterialLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Zhejiang Rongtai Electric MaterialLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Zhejiang Rongtai Electric MaterialLtd grew its EBIT by 15% 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 you can't view debt in total isolation; since Zhejiang Rongtai Electric MaterialLtd 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Zhejiang Rongtai Electric MaterialLtd 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. In the last three years, Zhejiang Rongtai Electric MaterialLtd's free cash flow amounted to 43% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Rongtai Electric MaterialLtd has net cash of CN¥977.7m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 15% over the last year. So is Zhejiang Rongtai Electric MaterialLtd's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Zhejiang Rongtai Electric MaterialLtd that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.

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