These 4 Measures Indicate That Shenzhen Honor Electronic (SZSE:300870) Is Using Debt Safely

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 note that Shenzhen Honor Electronic Co., Ltd. (SZSE:300870) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shenzhen Honor Electronic

What Is Shenzhen Honor Electronic's Debt?

As you can see below, at the end of September 2024, Shenzhen Honor Electronic had CN¥1.11b of debt, up from CN¥575.9m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.39b in cash, so it actually has CN¥277.0m net cash.

How Healthy Is Shenzhen Honor Electronic's Balance Sheet?

According to the last reported balance sheet, Shenzhen Honor Electronic had liabilities of CN¥2.20b due within 12 months, and liabilities of CN¥869.2m due beyond 12 months. Offsetting this, it had CN¥1.39b in cash and CN¥1.42b in receivables that were due within 12 months. So it has liabilities totalling CN¥253.6m more than its cash and near-term receivables, combined.

Of course, Shenzhen Honor Electronic has a market capitalization of CN¥11.2b, so these liabilities are probably manageable. 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.

Better yet, Shenzhen Honor Electronic grew its EBIT by 113% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. In the last two years, Shenzhen Honor Electronic's free cash flow amounted to 42% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

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¥277.0m in net cash. And we liked the look of last year's 113% year-on-year EBIT growth. So is Shenzhen Honor Electronic's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with Shenzhen Honor Electronic .

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.