Here's Why Huachangda Intelligent Equipment GroupLtd (SZSE:300278) Has A Meaningful Debt Burden

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Huachangda Intelligent Equipment Group Co.,Ltd. (SZSE:300278) 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 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. 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. 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.

Check out our latest analysis for Huachangda Intelligent Equipment GroupLtd

What Is Huachangda Intelligent Equipment GroupLtd's Net Debt?

As you can see below, Huachangda Intelligent Equipment GroupLtd had CN¥40.0m of debt at June 2024, down from CN¥65.8m a year prior. However, its balance sheet shows it holds CN¥429.7m in cash, so it actually has CN¥389.7m net cash.

How Strong Is Huachangda Intelligent Equipment GroupLtd's Balance Sheet?

The latest balance sheet data shows that Huachangda Intelligent Equipment GroupLtd had liabilities of CN¥1.14b due within a year, and liabilities of CN¥15.9m falling due after that. On the other hand, it had cash of CN¥429.7m and CN¥992.1m worth of receivables due within a year. So it actually has CN¥268.2m more liquid assets than total liabilities.

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

It is just as well that Huachangda Intelligent Equipment GroupLtd's load is not too heavy, because its EBIT was down 56% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Huachangda Intelligent Equipment GroupLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Huachangda Intelligent Equipment GroupLtd 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 two years, Huachangda Intelligent Equipment GroupLtd 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 Huachangda Intelligent Equipment GroupLtd has CN¥389.7m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Huachangda Intelligent Equipment GroupLtd's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. 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 Huachangda Intelligent Equipment GroupLtd .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.