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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. 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.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Shenzhen Honor Electronic

What Is Shenzhen Honor Electronic's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shenzhen Honor Electronic had CN¥429.4m of debt in March 2024, down from CN¥586.3m, one year before. However, its balance sheet shows it holds CN¥593.2m in cash, so it actually has CN¥163.9m net cash.

A Look At Shenzhen Honor Electronic's Liabilities

Zooming in on the latest balance sheet data, we can see that Shenzhen Honor Electronic had liabilities of CN¥1.49b due within 12 months and liabilities of CN¥365.9m due beyond that. Offsetting this, it had CN¥593.2m in cash and CN¥1.05b in receivables that were due within 12 months. So it has liabilities totalling CN¥217.0m more than its cash and near-term receivables, combined.

Since publicly traded Shenzhen Honor Electronic shares are worth a total of CN¥3.93b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. 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.

The good news is that Shenzhen Honor Electronic has increased its EBIT by 8.3% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shenzhen Honor Electronic can strengthen its balance sheet over time. 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 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 three years, Shenzhen Honor Electronic 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 look at a company's total liabilities, it is very reassuring that Shenzhen Honor Electronic has CN¥163.9m in net cash. And it also grew its EBIT by 8.3% over the last year. So we don't have any problem with Shenzhen Honor Electronic'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 example - Shenzhen Honor Electronic has 1 warning sign we think you should be aware of.

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.

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