Here's Why Hwaway Technology (SZSE:001380) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Hwaway Technology Corporation Limited (SZSE:001380) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Hwaway Technology

What Is Hwaway Technology's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Hwaway Technology had debt of CN¥68.6m, up from CN¥51.3m in one year. However, it does have CN¥440.5m in cash offsetting this, leading to net cash of CN¥371.9m.

How Strong Is Hwaway Technology's Balance Sheet?

We can see from the most recent balance sheet that Hwaway Technology had liabilities of CN¥757.6m falling due within a year, and liabilities of CN¥28.4m due beyond that. Offsetting these obligations, it had cash of CN¥440.5m as well as receivables valued at CN¥1.07b due within 12 months. So it actually has CN¥728.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Hwaway Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Hwaway Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Hwaway Technology has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hwaway Technology's earnings that will influence how the balance sheet holds up in the future. 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 Hwaway Technology 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, Hwaway Technology saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hwaway Technology has CN¥371.9m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 23% over the last year. So we are not troubled with Hwaway Technology's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Hwaway Technology (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

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.