Is Huachangda Intelligent Equipment GroupLtd (SZSE:300278) A Risky Investment?

Warren Buffett famously said, '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 Huachangda Intelligent Equipment Group Co.,Ltd. (SZSE:300278) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Huachangda Intelligent Equipment GroupLtd

What Is Huachangda Intelligent Equipment GroupLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Huachangda Intelligent Equipment GroupLtd had debt of CN¥60.8m, up from CN¥1.66m in one year. However, it does have CN¥560.2m in cash offsetting this, leading to net cash of CN¥499.4m.

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

According to the last reported balance sheet, Huachangda Intelligent Equipment GroupLtd had liabilities of CN¥1.37b due within 12 months, and liabilities of CN¥43.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥560.2m as well as receivables valued at CN¥912.6m due within 12 months. So it actually has CN¥57.0m more liquid assets than total liabilities.

This state of affairs indicates that Huachangda Intelligent Equipment GroupLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥4.90b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Huachangda Intelligent Equipment GroupLtd 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, Huachangda Intelligent Equipment GroupLtd turned things around in the last 12 months, delivering and EBIT of CN¥52m. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Huachangda Intelligent Equipment GroupLtd 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, Huachangda Intelligent Equipment GroupLtd 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 Huachangda Intelligent Equipment GroupLtd has net cash of CN¥499.4m, as well as more liquid assets than liabilities. So we are not troubled with Huachangda Intelligent Equipment GroupLtd's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs 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.

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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.