Does Shenzhen Honor Electronic (SZSE:300870) Have A Healthy Balance Sheet?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Shenzhen Honor Electronic Co., Ltd. (SZSE:300870) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Shenzhen Honor Electronic

How Much Debt Does Shenzhen Honor Electronic Carry?

As you can see below, Shenzhen Honor Electronic had CN¥575.9m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has CN¥685.4m in cash, leading to a CN¥109.5m net cash position.

How Healthy Is Shenzhen Honor Electronic's Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Honor Electronic had liabilities of CN¥1.60b falling due within a year, and liabilities of CN¥415.7m due beyond that. Offsetting this, it had CN¥685.4m in cash and CN¥1.04b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥283.2m.

Given Shenzhen Honor Electronic has a market capitalization of CN¥5.00b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Shenzhen Honor Electronic also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Shenzhen Honor Electronic made a loss at the EBIT level, last year, it was also good to see that it generated CN¥100m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shenzhen Honor Electronic's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shenzhen Honor Electronic 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 year, Shenzhen Honor Electronic actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Shenzhen Honor Electronic has CN¥109.5m in net cash. And it impressed us with free cash flow of CN¥130m, being 131% of its EBIT. So we don't think Shenzhen Honor Electronic's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. 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 2 warning signs for Shenzhen Honor Electronic (of which 1 is a bit unpleasant!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.