Shanghai Liangxin ElectricalLTD (SZSE:002706) Has A Pretty Healthy Balance Sheet

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 note that Shanghai Liangxin Electrical Co.,LTD. (SZSE:002706) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shanghai Liangxin ElectricalLTD

How Much Debt Does Shanghai Liangxin ElectricalLTD Carry?

You can click the graphic below for the historical numbers, but it shows that Shanghai Liangxin ElectricalLTD had CN¥102.1m of debt in September 2023, down from CN¥560.7m, one year before. But it also has CN¥1.18b in cash to offset that, meaning it has CN¥1.08b net cash.

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¥1.57b due within 12 months and liabilities of CN¥54.6m due beyond that. On the other hand, it had cash of CN¥1.18b and CN¥1.49b worth of receivables due within a year. So it can boast CN¥1.06b more liquid assets than total liabilities.

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

On the other hand, Shanghai Liangxin ElectricalLTD saw its EBIT drop by 6.8% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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'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. 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. Considering the last three years, Shanghai Liangxin ElectricalLTD actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Liangxin ElectricalLTD has net cash of CN¥1.08b, as well as more liquid assets than liabilities. So we don't have any problem with Shanghai Liangxin ElectricalLTD's use of debt. 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. For example, we've discovered 1 warning sign for Shanghai Liangxin ElectricalLTD that you should be aware of before investing here.

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.