Reach Machinery (SZSE:301596) Could Easily Take On More 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. Importantly, Reach Machinery Co., Ltd. (SZSE:301596) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Reach Machinery

How Much Debt Does Reach Machinery Carry?

The chart below, which you can click on for greater detail, shows that Reach Machinery had CN¥66.6m in debt in September 2024; about the same as the year before. But it also has CN¥458.1m in cash to offset that, meaning it has CN¥391.4m net cash.

How Healthy Is Reach Machinery's Balance Sheet?

The latest balance sheet data shows that Reach Machinery had liabilities of CN¥223.2m due within a year, and liabilities of CN¥61.6m falling due after that. Offsetting these obligations, it had cash of CN¥458.1m as well as receivables valued at CN¥246.0m due within 12 months. So it actually has CN¥419.2m more liquid assets than total liabilities.

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

The good news is that Reach Machinery has increased its EBIT by 2.8% 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 you can't view debt in total isolation; since Reach Machinery 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 Reach Machinery 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. During the last three years, Reach Machinery produced sturdy free cash flow equating to 66% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Reach Machinery has net cash of CN¥391.4m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥66m, being 66% of its EBIT. So is Reach Machinery's debt a risk? It doesn't seem so to us. 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 1 warning sign for Reach Machinery 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.