Is Shanghai Liangxin ElectricalLTD (SZSE:002706) Using Too Much Debt?

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.' 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. We can see that Shanghai Liangxin Electrical Co.,LTD. (SZSE:002706) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Shanghai Liangxin ElectricalLTD

What Is Shanghai Liangxin ElectricalLTD's Net Debt?

As you can see below, Shanghai Liangxin ElectricalLTD had CN¥102.3m of debt at March 2024, down from CN¥329.6m a year prior. However, it does have CN¥1.26b in cash offsetting this, leading to net cash of CN¥1.15b.

A Look At Shanghai Liangxin ElectricalLTD's Liabilities

Zooming in on the latest balance sheet data, we can see that Shanghai Liangxin ElectricalLTD had liabilities of CN¥1.32b due within 12 months and liabilities of CN¥51.4m due beyond that. On the other hand, it had cash of CN¥1.26b and CN¥1.16b worth of receivables due within a year. So it actually has CN¥1.05b more liquid assets than total liabilities.

This surplus suggests that Shanghai Liangxin ElectricalLTD has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shanghai Liangxin ElectricalLTD boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Shanghai Liangxin ElectricalLTD has been able to increase its EBIT by 30% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shanghai Liangxin ElectricalLTD's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shanghai Liangxin ElectricalLTD 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, Shanghai Liangxin ElectricalLTD recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shanghai Liangxin ElectricalLTD has CN¥1.15b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 30% over the last year. So is Shanghai Liangxin ElectricalLTD'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. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Shanghai Liangxin ElectricalLTD that you should be aware of.

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.