Here's Why Shenzhen Changhong Technology (SZSE:300151) Has A Meaningful Debt Burden

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Shenzhen Changhong Technology Co., Ltd. (SZSE:300151) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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, 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.

View our latest analysis for Shenzhen Changhong Technology

How Much Debt Does Shenzhen Changhong Technology Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Shenzhen Changhong Technology had debt of CN¥608.3m, up from CN¥545.1m in one year. However, its balance sheet shows it holds CN¥755.1m in cash, so it actually has CN¥146.7m net cash.

How Healthy Is Shenzhen Changhong Technology's Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Changhong Technology had liabilities of CN¥291.8m falling due within a year, and liabilities of CN¥555.4m due beyond that. Offsetting these obligations, it had cash of CN¥755.1m as well as receivables valued at CN¥266.0m due within 12 months. So it actually has CN¥173.9m more liquid assets than total liabilities.

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

Shareholders should be aware that Shenzhen Changhong Technology's EBIT was down 64% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Changhong 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. While Shenzhen Changhong 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. Over the last three years, Shenzhen Changhong Technology saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Changhong Technology has net cash of CN¥146.7m, as well as more liquid assets than liabilities. Despite the cash, we do find Shenzhen Changhong Technology's EBIT growth rate concerning, so we're not particularly comfortable with the stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Shenzhen Changhong Technology (of which 1 is potentially serious!) 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.