These 4 Measures Indicate That Xi'an Triangle DefenseLtd (SZSE:300775) Is Using Debt Reasonably Well

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.' 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. Importantly, Xi'an Triangle Defense Co.,Ltd (SZSE:300775) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Xi'an Triangle DefenseLtd

How Much Debt Does Xi'an Triangle DefenseLtd Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Xi'an Triangle DefenseLtd had debt of CN¥1.50b, up from CN¥905.8m in one year. However, it does have CN¥3.31b in cash offsetting this, leading to net cash of CN¥1.81b.

How Healthy Is Xi'an Triangle DefenseLtd's Balance Sheet?

We can see from the most recent balance sheet that Xi'an Triangle DefenseLtd had liabilities of CN¥2.07b falling due within a year, and liabilities of CN¥1.02b due beyond that. On the other hand, it had cash of CN¥3.31b and CN¥2.73b worth of receivables due within a year. So it actually has CN¥2.95b more liquid assets than total liabilities.

This surplus suggests that Xi'an Triangle DefenseLtd is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Xi'an Triangle DefenseLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Xi'an Triangle DefenseLtd has increased its EBIT by 2.7% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Xi'an Triangle DefenseLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Xi'an Triangle DefenseLtd 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, Xi'an Triangle DefenseLtd recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Xi'an Triangle DefenseLtd has CN¥1.81b in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 2.7% in the last twelve months. So we don't have any problem with Xi'an Triangle DefenseLtd'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 2 warning signs for Xi'an Triangle DefenseLtd (1 is a bit unpleasant) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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