Here's Why Zhejiang Sanhua Intelligent ControlsLtd (SZSE:002050) Can Manage Its Debt Responsibly

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.' 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 Zhejiang Sanhua Intelligent Controls Co.,Ltd (SZSE:002050) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

Check out our latest analysis for Zhejiang Sanhua Intelligent ControlsLtd

How Much Debt Does Zhejiang Sanhua Intelligent ControlsLtd Carry?

As you can see below, Zhejiang Sanhua Intelligent ControlsLtd had CN¥3.87b of debt at March 2024, down from CN¥6.44b a year prior. However, its balance sheet shows it holds CN¥5.66b in cash, so it actually has CN¥1.79b net cash.

How Strong Is Zhejiang Sanhua Intelligent ControlsLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zhejiang Sanhua Intelligent ControlsLtd had liabilities of CN¥11.3b due within 12 months and liabilities of CN¥2.88b due beyond that. Offsetting these obligations, it had cash of CN¥5.66b as well as receivables valued at CN¥9.18b due within 12 months. So it can boast CN¥698.2m more liquid assets than total liabilities.

Having regard to Zhejiang Sanhua Intelligent ControlsLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥74.8b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Zhejiang Sanhua Intelligent ControlsLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Zhejiang Sanhua Intelligent ControlsLtd has boosted its EBIT by 31%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhejiang Sanhua Intelligent ControlsLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Zhejiang Sanhua Intelligent ControlsLtd 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, Zhejiang Sanhua Intelligent ControlsLtd recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Sanhua Intelligent ControlsLtd has CN¥1.79b in net cash and a decent-looking balance sheet. And we liked the look of last year's 31% year-on-year EBIT growth. So we don't have any problem with Zhejiang Sanhua Intelligent ControlsLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Zhejiang Sanhua Intelligent ControlsLtd 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.

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