Here's Why Xizi Clean Energy Equipment Manufacturing (SZSE:002534) 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.' 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. Importantly, Xizi Clean Energy Equipment Manufacturing Co., Ltd. (SZSE:002534) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

See our latest analysis for Xizi Clean Energy Equipment Manufacturing

What Is Xizi Clean Energy Equipment Manufacturing's Debt?

As you can see below, Xizi Clean Energy Equipment Manufacturing had CN¥2.07b of debt at June 2024, down from CN¥2.82b a year prior. But it also has CN¥3.19b in cash to offset that, meaning it has CN¥1.12b net cash.

How Strong Is Xizi Clean Energy Equipment Manufacturing's Balance Sheet?

The latest balance sheet data shows that Xizi Clean Energy Equipment Manufacturing had liabilities of CN¥8.61b due within a year, and liabilities of CN¥2.36b falling due after that. Offsetting this, it had CN¥3.19b in cash and CN¥4.70b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.08b.

While this might seem like a lot, it is not so bad since Xizi Clean Energy Equipment Manufacturing has a market capitalization of CN¥7.09b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Xizi Clean Energy Equipment Manufacturing boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Xizi Clean Energy Equipment Manufacturing turned things around in the last 12 months, delivering and EBIT of CN¥256m. 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 Xizi Clean Energy Equipment Manufacturing 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Xizi Clean Energy Equipment Manufacturing 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. During the last year, Xizi Clean Energy Equipment Manufacturing generated free cash flow amounting to a very robust 94% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While Xizi Clean Energy Equipment Manufacturing does have more liabilities than liquid assets, it also has net cash of CN¥1.12b. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in CN¥240m. So we are not troubled with Xizi Clean Energy Equipment Manufacturing'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. Be aware that Xizi Clean Energy Equipment Manufacturing is showing 1 warning sign in our investment analysis , you should know about...

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.