Zhe Jiang Headman MachineryLtd (SHSE:688577) Has A Pretty Healthy Balance Sheet

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 Zhe Jiang Headman Machinery Co.,Ltd. (SHSE:688577) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Zhe Jiang Headman MachineryLtd

How Much Debt Does Zhe Jiang Headman MachineryLtd Carry?

As you can see below, at the end of September 2024, Zhe Jiang Headman MachineryLtd had CN¥139.5m of debt, up from CN¥122.2m a year ago. Click the image for more detail. However, it does have CN¥177.6m in cash offsetting this, leading to net cash of CN¥38.1m.

A Look At Zhe Jiang Headman MachineryLtd's Liabilities

According to the last reported balance sheet, Zhe Jiang Headman MachineryLtd had liabilities of CN¥524.3m due within 12 months, and liabilities of CN¥99.3m due beyond 12 months. Offsetting this, it had CN¥177.6m in cash and CN¥257.6m in receivables that were due within 12 months. So it has liabilities totalling CN¥188.4m more than its cash and near-term receivables, combined.

Of course, Zhe Jiang Headman MachineryLtd has a market capitalization of CN¥4.60b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Zhe Jiang Headman MachineryLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Zhe Jiang Headman MachineryLtd grew its EBIT by 2.8% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Zhe Jiang Headman MachineryLtd 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. While Zhe Jiang Headman MachineryLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Zhe Jiang Headman MachineryLtd saw substantial negative free cash flow, in total. 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

We could understand if investors are concerned about Zhe Jiang Headman MachineryLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥38.1m. On top of that, it increased its EBIT by 2.8% in the last twelve months. So we don't have any problem with Zhe Jiang Headman MachineryLtd's use of debt. 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. To that end, you should learn about the 3 warning signs we've spotted with Zhe Jiang Headman MachineryLtd (including 2 which shouldn't be ignored) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.