Is Himile Mechanical Science and Technology (Shandong) (SZSE:002595) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Himile Mechanical Science and Technology (Shandong) Co., Ltd (SZSE:002595) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Himile Mechanical Science and Technology (Shandong)

What Is Himile Mechanical Science and Technology (Shandong)'s Net Debt?

As you can see below, at the end of September 2024, Himile Mechanical Science and Technology (Shandong) had CN¥111.6m of debt, up from CN¥39.6m a year ago. Click the image for more detail. However, it does have CN¥1.81b in cash offsetting this, leading to net cash of CN¥1.70b.

A Look At Himile Mechanical Science and Technology (Shandong)'s Liabilities

The latest balance sheet data shows that Himile Mechanical Science and Technology (Shandong) had liabilities of CN¥1.39b due within a year, and liabilities of CN¥303.2m falling due after that. Offsetting these obligations, it had cash of CN¥1.81b as well as receivables valued at CN¥3.39b due within 12 months. So it actually has CN¥3.52b more liquid assets than total liabilities.

This short term liquidity is a sign that Himile Mechanical Science and Technology (Shandong) could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Himile Mechanical Science and Technology (Shandong) has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Himile Mechanical Science and Technology (Shandong) has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Himile Mechanical Science and Technology (Shandong) 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Himile Mechanical Science and Technology (Shandong) 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. Looking at the most recent three years, Himile Mechanical Science and Technology (Shandong) recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Himile Mechanical Science and Technology (Shandong) has CN¥1.70b in net cash and a decent-looking balance sheet. And we liked the look of last year's 25% year-on-year EBIT growth. So we don't think Himile Mechanical Science and Technology (Shandong)'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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Himile Mechanical Science and Technology (Shandong) 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.