Here's Why Hainan Jinpan Smart Technology (SHSE:688676) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Hainan Jinpan Smart Technology Co., Ltd. (SHSE:688676) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Hainan Jinpan Smart Technology

How Much Debt Does Hainan Jinpan Smart Technology Carry?

The image below, which you can click on for greater detail, shows that Hainan Jinpan Smart Technology had debt of CN¥1.63b at the end of September 2024, a reduction from CN¥1.87b over a year. On the flip side, it has CN¥781.1m in cash leading to net debt of about CN¥847.8m.

How Healthy Is Hainan Jinpan Smart Technology's Balance Sheet?

According to the last reported balance sheet, Hainan Jinpan Smart Technology had liabilities of CN¥4.26b due within 12 months, and liabilities of CN¥871.5m due beyond 12 months. On the other hand, it had cash of CN¥781.1m and CN¥3.65b worth of receivables due within a year. So it has liabilities totalling CN¥707.8m more than its cash and near-term receivables, combined.

Given Hainan Jinpan Smart Technology has a market capitalization of CN¥14.6b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Hainan Jinpan Smart Technology's net debt is only 1.0 times its EBITDA. And its EBIT easily covers its interest expense, being 15.5 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Hainan Jinpan Smart Technology has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hainan Jinpan Smart Technology 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Hainan Jinpan Smart Technology 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.

Our View

Hainan Jinpan Smart Technology's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that Hainan Jinpan Smart Technology can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. For instance, we've identified 2 warning signs for Hainan Jinpan Smart Technology 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.