Here's Why Shenzhen VAPEL Power Supply Technology (SZSE:301516) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 VAPEL Power Supply Technology Co., Ltd. (SZSE:301516) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 VAPEL Power Supply Technology

How Much Debt Does Shenzhen VAPEL Power Supply Technology Carry?

As you can see below, Shenzhen VAPEL Power Supply Technology had CN¥64.7m of debt at March 2024, down from CN¥162.0m a year prior. But it also has CN¥296.0m in cash to offset that, meaning it has CN¥231.4m net cash.

How Strong Is Shenzhen VAPEL Power Supply Technology's Balance Sheet?

The latest balance sheet data shows that Shenzhen VAPEL Power Supply Technology had liabilities of CN¥364.9m due within a year, and liabilities of CN¥10.2m falling due after that. Offsetting this, it had CN¥296.0m in cash and CN¥282.0m in receivables that were due within 12 months. So it actually has CN¥202.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Shenzhen VAPEL Power Supply Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shenzhen VAPEL Power Supply Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Shenzhen VAPEL Power Supply Technology's saving grace is its low debt levels, because its EBIT has tanked 46% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shenzhen VAPEL Power Supply Technology 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shenzhen VAPEL Power Supply Technology 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 three years, Shenzhen VAPEL Power Supply Technology's free cash flow amounted to 45% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen VAPEL Power Supply Technology has net cash of CN¥231.4m, as well as more liquid assets than liabilities. So we don't have any problem with Shenzhen VAPEL Power Supply Technology'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. Case in point: We've spotted 3 warning signs for Shenzhen VAPEL Power Supply Technology you should be aware of, and 2 of them are significant.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.