These 4 Measures Indicate That Shenzhen Envicool Technology (SZSE:002837) Is Using Debt Safely

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.' 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 should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Shenzhen Envicool Technology

What Is Shenzhen Envicool Technology's Net Debt?

As you can see below, Shenzhen Envicool Technology had CN¥620.9m of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has CN¥659.6m in cash, leading to a CN¥38.7m net cash position.

How Healthy Is Shenzhen Envicool Technology's Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Envicool Technology had liabilities of CN¥2.11b falling due within a year, and liabilities of CN¥202.5m due beyond that. Offsetting these obligations, it had cash of CN¥659.6m as well as receivables valued at CN¥2.35b due within 12 months. So it actually has CN¥696.3m more liquid assets than total liabilities.

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

On top of that, Shenzhen Envicool Technology grew its EBIT by 53% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shenzhen Envicool Technology 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. In the last three years, Shenzhen Envicool Technology's free cash flow amounted to 47% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

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¥38.7m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 53% over the last year. So is Shenzhen Envicool Technology's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Shenzhen Envicool Technology's earnings per share history for free.

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.