These 4 Measures Indicate That Hainan Jinpan Smart Technology (SHSE:688676) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Hainan Jinpan Smart Technology Co., Ltd. (SHSE:688676) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hainan Jinpan Smart Technology

What Is Hainan Jinpan Smart Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Hainan Jinpan Smart Technology had CN¥1.41b of debt in June 2024, down from CN¥1.48b, one year before. However, it also had CN¥747.7m in cash, and so its net debt is CN¥658.1m.

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

According to the last reported balance sheet, Hainan Jinpan Smart Technology had liabilities of CN¥3.91b due within 12 months, and liabilities of CN¥677.9m due beyond 12 months. Offsetting these obligations, it had cash of CN¥747.7m as well as receivables valued at CN¥3.30b due within 12 months. So it has liabilities totalling CN¥545.7m more than its cash and near-term receivables, combined.

Of course, Hainan Jinpan Smart Technology has a market capitalization of CN¥13.5b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Hainan Jinpan Smart Technology has a low net debt to EBITDA ratio of only 0.78. And its EBIT covers its interest expense a whopping 28.9 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Hainan Jinpan Smart Technology grew its EBIT by 82% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Hainan Jinpan Smart Technology'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.

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. Looking at all the aforementioned factors together, it strikes us that Hainan Jinpan Smart Technology can handle its debt fairly comfortably. 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. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for Hainan Jinpan Smart Technology (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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.