Here's Why Shenzhen Envicool Technology (SZSE:002837) Can Manage Its Debt Responsibly

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.' 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. As with many other companies Shenzhen Envicool Technology Co., Ltd. (SZSE:002837) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Shenzhen Envicool Technology

What Is Shenzhen Envicool Technology's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Shenzhen Envicool Technology had debt of CN¥518.4m, up from CN¥485.0m in one year. However, its balance sheet shows it holds CN¥650.6m in cash, so it actually has CN¥132.2m net cash.

How Healthy Is Shenzhen Envicool Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen Envicool Technology had liabilities of CN¥1.91b due within 12 months and liabilities of CN¥205.7m due beyond that. Offsetting this, it had CN¥650.6m in cash and CN¥2.14b in receivables that were due within 12 months. So it can boast CN¥682.1m more liquid assets than total liabilities.

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

Even more impressive was the fact that Shenzhen Envicool Technology grew its EBIT by 151% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shenzhen Envicool Technology'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. While Shenzhen Envicool Technology 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. In the last three years, Shenzhen Envicool Technology created free cash flow amounting to 8.5% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Envicool Technology has net cash of CN¥132.2m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 151% over the last year. So we don't think Shenzhen Envicool Technology's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Shenzhen Envicool Technology , and understanding them should be part of your investment process.

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.