Does Nanxing Machinery (SZSE:002757) Have A Healthy Balance Sheet?

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.' 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 Nanxing Machinery Co., Ltd. (SZSE:002757) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Nanxing Machinery

What Is Nanxing Machinery's Debt?

As you can see below, at the end of September 2024, Nanxing Machinery had CN¥652.0m of debt, up from CN¥615.2m a year ago. Click the image for more detail. But it also has CN¥747.9m in cash to offset that, meaning it has CN¥95.9m net cash.

A Look At Nanxing Machinery's Liabilities

Zooming in on the latest balance sheet data, we can see that Nanxing Machinery had liabilities of CN¥798.5m due within 12 months and liabilities of CN¥736.0m due beyond that. Offsetting this, it had CN¥747.9m in cash and CN¥484.0m in receivables that were due within 12 months. So its liabilities total CN¥302.6m more than the combination of its cash and short-term receivables.

Since publicly traded Nanxing Machinery shares are worth a total of CN¥4.14b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Nanxing Machinery also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Nanxing Machinery has seen its EBIT plunge 14% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Nanxing Machinery's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Nanxing Machinery 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. Over the most recent three years, Nanxing Machinery recorded free cash flow worth 68% 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

We could understand if investors are concerned about Nanxing Machinery's liabilities, but we can be reassured by the fact it has has net cash of CN¥95.9m. And it impressed us with free cash flow of CN¥157m, being 68% of its EBIT. So we are not troubled with Nanxing Machinery's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for Nanxing Machinery (of which 2 make us uncomfortable!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.