Bozhon Precision Industry TechnologyLtd (SHSE:688097) Seems To Use Debt Quite Sensibly

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. As with many other companies Bozhon Precision Industry Technology Co.,Ltd. (SHSE:688097) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Bozhon Precision Industry TechnologyLtd

What Is Bozhon Precision Industry TechnologyLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Bozhon Precision Industry TechnologyLtd had debt of CN¥1.77b, up from CN¥1.63b in one year. On the flip side, it has CN¥1.29b in cash leading to net debt of about CN¥480.7m.

A Look At Bozhon Precision Industry TechnologyLtd's Liabilities

We can see from the most recent balance sheet that Bozhon Precision Industry TechnologyLtd had liabilities of CN¥4.18b falling due within a year, and liabilities of CN¥444.3m due beyond that. Offsetting these obligations, it had cash of CN¥1.29b as well as receivables valued at CN¥3.08b due within 12 months. So it has liabilities totalling CN¥242.3m more than its cash and near-term receivables, combined.

Since publicly traded Bozhon Precision Industry TechnologyLtd shares are worth a total of CN¥11.9b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Bozhon Precision Industry TechnologyLtd has net debt of just 0.95 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 9.0 times the interest expense over the last year. Fortunately, Bozhon Precision Industry TechnologyLtd grew its EBIT by 8.0% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Bozhon Precision Industry TechnologyLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Considering the last three years, Bozhon Precision Industry TechnologyLtd actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Based on what we've seen Bozhon Precision Industry TechnologyLtd is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we thought its interest cover was a positive. Considering this range of data points, we think Bozhon Precision Industry TechnologyLtd is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Over time, share prices tend to follow earnings per share, so if you're interested in Bozhon Precision Industry TechnologyLtd, you may well want to click here to check an interactive graph of its earnings per share history.

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.