Zhongshan Broad-Ocean Motor (SZSE:002249) Could Easily Take On More Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Zhongshan Broad-Ocean Motor Co., Ltd. (SZSE:002249) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

Check out our latest analysis for Zhongshan Broad-Ocean Motor

What Is Zhongshan Broad-Ocean Motor's Net Debt?

As you can see below, Zhongshan Broad-Ocean Motor had CN¥47.9m of debt at June 2024, down from CN¥75.8m a year prior. But on the other hand it also has CN¥3.79b in cash, leading to a CN¥3.74b net cash position.

How Healthy Is Zhongshan Broad-Ocean Motor's Balance Sheet?

We can see from the most recent balance sheet that Zhongshan Broad-Ocean Motor had liabilities of CN¥6.66b falling due within a year, and liabilities of CN¥1.00b due beyond that. On the other hand, it had cash of CN¥3.79b and CN¥4.24b worth of receivables due within a year. So it can boast CN¥364.7m more liquid assets than total liabilities.

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

In addition to that, we're happy to report that Zhongshan Broad-Ocean Motor has boosted its EBIT by 58%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Zhongshan Broad-Ocean Motor's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Zhongshan Broad-Ocean Motor 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, Zhongshan Broad-Ocean Motor actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhongshan Broad-Ocean Motor has net cash of CN¥3.74b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥1.9b, being 250% of its EBIT. So we don't think Zhongshan Broad-Ocean Motor's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Zhongshan Broad-Ocean Motor .

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.