Shanghai Hugong Electric GroupLtd (SHSE:603131) Could Easily Take On More Debt

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 Shanghai Hugong Electric Group Co.,Ltd. (SHSE:603131) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Shanghai Hugong Electric GroupLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shanghai Hugong Electric GroupLtd had CN¥491.3m of debt, an increase on CN¥434.6m, over one year. But on the other hand it also has CN¥976.6m in cash, leading to a CN¥485.3m net cash position.

A Look At Shanghai Hugong Electric GroupLtd's Liabilities

We can see from the most recent balance sheet that Shanghai Hugong Electric GroupLtd had liabilities of CN¥577.3m falling due within a year, and liabilities of CN¥447.7m due beyond that. On the other hand, it had cash of CN¥976.6m and CN¥430.5m worth of receivables due within a year. So it actually has CN¥382.0m more liquid assets than total liabilities.

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

See our latest analysis for Shanghai Hugong Electric GroupLtd

Even more impressive was the fact that Shanghai Hugong Electric GroupLtd grew its EBIT by 420% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shanghai Hugong Electric GroupLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shanghai Hugong Electric GroupLtd 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. Over the last three years, Shanghai Hugong Electric GroupLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shanghai Hugong Electric GroupLtd has CN¥485.3m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥187m, being 185% of its EBIT. So we don't think Shanghai Hugong Electric GroupLtd's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Shanghai Hugong Electric GroupLtd 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.