These 4 Measures Indicate That Huaming Power EquipmentLtd (SZSE:002270) Is Using Debt Safely

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Huaming Power Equipment Co.,Ltd (SZSE:002270) does use debt in its business. But is this debt a concern to shareholders?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Huaming Power EquipmentLtd

What Is Huaming Power EquipmentLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Huaming Power EquipmentLtd had CN¥478.9m of debt, an increase on CN¥355.6m, over one year. But on the other hand it also has CN¥939.0m in cash, leading to a CN¥460.1m net cash position.

How Strong Is Huaming Power EquipmentLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Huaming Power EquipmentLtd had liabilities of CN¥1.04b due within 12 months and liabilities of CN¥262.6m due beyond that. Offsetting this, it had CN¥939.0m in cash and CN¥1.41b in receivables that were due within 12 months. So it actually has CN¥1.05b more liquid assets than total liabilities.

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

The good news is that Huaming Power EquipmentLtd has increased its EBIT by 7.2% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Huaming Power EquipmentLtd'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, a company can only pay off debt with cold hard cash, not accounting profits. While Huaming Power EquipmentLtd 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, Huaming Power EquipmentLtd recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Huaming Power EquipmentLtd has CN¥460.1m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥553m, being 91% of its EBIT. So is Huaming Power EquipmentLtd's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with Huaming Power EquipmentLtd .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.