Shaanxi Huada Science TechnologyLtd (SZSE:301517) Takes On Some Risk With Its Use Of Debt

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 Shaanxi Huada Science Technology Co.,Ltd. (SZSE:301517) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Shaanxi Huada Science TechnologyLtd

What Is Shaanxi Huada Science TechnologyLtd's Debt?

The image below, which you can click on for greater detail, shows that Shaanxi Huada Science TechnologyLtd had debt of CN¥288.7m at the end of September 2024, a reduction from CN¥422.8m over a year. However, its balance sheet shows it holds CN¥566.9m in cash, so it actually has CN¥278.2m net cash.

How Healthy Is Shaanxi Huada Science TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Shaanxi Huada Science TechnologyLtd had liabilities of CN¥607.7m due within 12 months, and liabilities of CN¥205.9m due beyond 12 months. Offsetting this, it had CN¥566.9m in cash and CN¥818.8m in receivables that were due within 12 months. So it actually has CN¥572.2m more liquid assets than total liabilities.

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

The modesty of its debt load may become crucial for Shaanxi Huada Science TechnologyLtd if management cannot prevent a repeat of the 57% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shaanxi Huada Science TechnologyLtd can strengthen its balance sheet over time. 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. Shaanxi Huada Science TechnologyLtd 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. During the last three years, Shaanxi Huada Science TechnologyLtd burned a lot of cash. 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 we empathize with investors who find debt concerning, you should keep in mind that Shaanxi Huada Science TechnologyLtd has net cash of CN¥278.2m, as well as more liquid assets than liabilities. So while Shaanxi Huada Science TechnologyLtd does not have a great balance sheet, it's certainly not too bad. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Shaanxi Huada Science TechnologyLtd has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.