Weihai Honglin Electronic (SZSE:301439) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Weihai Honglin Electronic Co., Ltd. (SZSE:301439) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

See our latest analysis for Weihai Honglin Electronic

How Much Debt Does Weihai Honglin Electronic Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Weihai Honglin Electronic had debt of CN¥52.3m, up from CN¥45.0m in one year. But it also has CN¥997.3m in cash to offset that, meaning it has CN¥945.0m net cash.

How Healthy Is Weihai Honglin Electronic's Balance Sheet?

The latest balance sheet data shows that Weihai Honglin Electronic had liabilities of CN¥1.15b due within a year, and liabilities of CN¥42.4m falling due after that. Offsetting these obligations, it had cash of CN¥997.3m as well as receivables valued at CN¥1.40b due within 12 months. So it can boast CN¥1.21b more liquid assets than total liabilities.

This surplus suggests that Weihai Honglin Electronic is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Weihai Honglin Electronic boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Weihai Honglin Electronic's load is not too heavy, because its EBIT was down 43% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Weihai Honglin Electronic 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. Weihai Honglin Electronic 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 three years, Weihai Honglin 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 investigate a company's debt, in this case Weihai Honglin Electronic has CN¥945.0m in net cash and a decent-looking balance sheet. So we don't have any problem with Weihai Honglin Electronic's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Weihai Honglin Electronic is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.