Does Changhong Huayi Compressor (SZSE:000404) Have A Healthy Balance Sheet?

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.' 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 Changhong Huayi Compressor Co., Ltd. (SZSE:000404) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, 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 Changhong Huayi Compressor

What Is Changhong Huayi Compressor's Debt?

The chart below, which you can click on for greater detail, shows that Changhong Huayi Compressor had CN¥1.56b in debt in September 2023; about the same as the year before. However, it does have CN¥5.17b in cash offsetting this, leading to net cash of CN¥3.61b.

How Strong Is Changhong Huayi Compressor's Balance Sheet?

The latest balance sheet data shows that Changhong Huayi Compressor had liabilities of CN¥7.61b due within a year, and liabilities of CN¥683.8m falling due after that. On the other hand, it had cash of CN¥5.17b and CN¥3.53b worth of receivables due within a year. So it can boast CN¥413.2m more liquid assets than total liabilities.

This short term liquidity is a sign that Changhong Huayi Compressor could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Changhong Huayi Compressor boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Changhong Huayi Compressor grew its EBIT by 245% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Changhong Huayi Compressor 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. Changhong Huayi Compressor 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. Over the last three years, Changhong Huayi Compressor actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Changhong Huayi Compressor has CN¥3.61b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 263% of that EBIT to free cash flow, bringing in CN¥178m. So we don't think Changhong Huayi Compressor's use of debt is risky. 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. We've identified 1 warning sign with Changhong Huayi Compressor , and understanding them should be part of your investment process.

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.