Reach Machinery (SZSE:301596) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Reach Machinery Co., Ltd. (SZSE:301596) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Reach Machinery

How Much Debt Does Reach Machinery Carry?

As you can see below, Reach Machinery had CN¥66.6m of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥458.1m in cash offsetting this, leading to net cash of CN¥391.4m.

How Strong Is Reach Machinery's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Reach Machinery had liabilities of CN¥223.2m due within 12 months and liabilities of CN¥61.6m due beyond that. On the other hand, it had cash of CN¥458.1m and CN¥246.0m worth of receivables due within a year. So it actually has CN¥419.2m more liquid assets than total liabilities.

This surplus suggests that Reach Machinery has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Reach Machinery will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Reach Machinery 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 most recent three years, Reach Machinery recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Reach Machinery has CN¥391.4m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 66% of that EBIT to free cash flow, bringing in CN¥66m. So we don't think Reach Machinery's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Reach Machinery has 1 warning sign we think you should be aware of.

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.