Here's Why Zhongyan Technology (SZSE:003001) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Zhongyan Technology Co., Ltd. (SZSE:003001) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Zhongyan Technology

What Is Zhongyan Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Zhongyan Technology had CN¥51.2m of debt, an increase on CN¥26.4m, over one year. However, it does have CN¥468.6m in cash offsetting this, leading to net cash of CN¥417.5m.

How Strong Is Zhongyan Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zhongyan Technology had liabilities of CN¥552.7m due within 12 months and liabilities of CN¥7.23m due beyond that. Offsetting this, it had CN¥468.6m in cash and CN¥987.0m in receivables that were due within 12 months. So it actually has CN¥895.7m more liquid assets than total liabilities.

This surplus suggests that Zhongyan Technology is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Zhongyan Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Zhongyan Technology turned things around in the last 12 months, delivering and EBIT of CN¥29m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zhongyan Technology can strengthen its balance sheet over time. 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. Zhongyan 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. Over the last year, Zhongyan Technology saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhongyan Technology has CN¥417.5m in net cash and a decent-looking balance sheet. So we don't have any problem with Zhongyan Technology's use of debt. 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. To that end, you should be aware of the 1 warning sign we've spotted with Zhongyan Technology .

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.