These 4 Measures Indicate That Beijing Worldia Diamond ToolsLtd (SHSE:688028) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Beijing Worldia Diamond Tools Co.,Ltd. (SHSE:688028) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

View our latest analysis for Beijing Worldia Diamond ToolsLtd

What Is Beijing Worldia Diamond ToolsLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Beijing Worldia Diamond ToolsLtd had CN¥126.4m of debt, an increase on CN¥12.0m, over one year. However, it does have CN¥219.2m in cash offsetting this, leading to net cash of CN¥92.8m.

How Strong Is Beijing Worldia Diamond ToolsLtd's Balance Sheet?

According to the last reported balance sheet, Beijing Worldia Diamond ToolsLtd had liabilities of CN¥257.3m due within 12 months, and liabilities of CN¥83.9m due beyond 12 months. Offsetting these obligations, it had cash of CN¥219.2m as well as receivables valued at CN¥247.4m due within 12 months. So it actually has CN¥125.4m more liquid assets than total liabilities.

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

On the other hand, Beijing Worldia Diamond ToolsLtd saw its EBIT drop by 4.1% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Beijing Worldia Diamond ToolsLtd 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Beijing Worldia Diamond ToolsLtd 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. During the last three years, Beijing Worldia Diamond ToolsLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Beijing Worldia Diamond ToolsLtd has net cash of CN¥92.8m, as well as more liquid assets than liabilities. So we don't have any problem with Beijing Worldia Diamond ToolsLtd's use of debt. 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 instance, we've identified 2 warning signs for Beijing Worldia Diamond ToolsLtd that you should be aware of.

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.