Is Shenzhen Zhaowei Machinery & Electronics (SZSE:003021) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that Shenzhen Zhaowei Machinery & Electronics Co., Ltd. (SZSE:003021) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Shenzhen Zhaowei Machinery & Electronics

How Much Debt Does Shenzhen Zhaowei Machinery & Electronics Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Shenzhen Zhaowei Machinery & Electronics had debt of CN¥37.5m, up from CN¥33.0m in one year. However, it does have CN¥982.5m in cash offsetting this, leading to net cash of CN¥944.9m.

How Healthy Is Shenzhen Zhaowei Machinery & Electronics' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen Zhaowei Machinery & Electronics had liabilities of CN¥603.0m due within 12 months and liabilities of CN¥80.1m due beyond that. Offsetting this, it had CN¥982.5m in cash and CN¥394.0m in receivables that were due within 12 months. So it actually has CN¥693.4m more liquid assets than total liabilities.

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

On top of that, Shenzhen Zhaowei Machinery & Electronics grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. 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 Zhaowei Machinery & Electronics'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. While Shenzhen Zhaowei Machinery & Electronics 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. Considering the last three years, Shenzhen Zhaowei Machinery & Electronics 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 it is always sensible to investigate a company's debt, in this case Shenzhen Zhaowei Machinery & Electronics has CN¥944.9m in net cash and a decent-looking balance sheet. And we liked the look of last year's 43% year-on-year EBIT growth. So we don't have any problem with Shenzhen Zhaowei Machinery & Electronics'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 instance, we've identified 1 warning sign for Shenzhen Zhaowei Machinery & Electronics that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.

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