Here's Why Shenzhen KSTAR Science and Technology (SZSE:002518) Can Manage Its Debt Responsibly

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 Shenzhen KSTAR Science and Technology Co., Ltd. (SZSE:002518) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Shenzhen KSTAR Science and Technology

How Much Debt Does Shenzhen KSTAR Science and Technology Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Shenzhen KSTAR Science and Technology had debt of CN¥45.0m, up from none in one year. But it also has CN¥608.1m in cash to offset that, meaning it has CN¥563.1m net cash.

How Strong Is Shenzhen KSTAR Science and Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen KSTAR Science and Technology had liabilities of CN¥1.94b due within 12 months and liabilities of CN¥298.1m due beyond that. Offsetting this, it had CN¥608.1m in cash and CN¥1.63b in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Shenzhen KSTAR Science and Technology's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥9.24b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Shenzhen KSTAR Science and Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Shenzhen KSTAR Science and Technology's saving grace is its low debt levels, because its EBIT has tanked 55% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shenzhen KSTAR Science and Technology 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. While Shenzhen KSTAR Science and 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 most recent three years, Shenzhen KSTAR Science and Technology recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen KSTAR Science and Technology has net cash of CN¥563.1m, as well as more liquid assets than liabilities. So we are not troubled with Shenzhen KSTAR Science and Technology's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Shenzhen KSTAR Science and Technology has 2 warning signs (and 1 which is significant) we think you should know about.

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.