Is NCS Testing Technology (SZSE:300797) Using Too Much Debt?

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.' 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 NCS Testing Technology Co., Ltd. (SZSE:300797) does have debt on its balance sheet. But is this debt a concern to shareholders?

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When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does NCS Testing Technology Carry?

The image below, which you can click on for greater detail, shows that at September 2024 NCS Testing Technology had debt of CN¥15.1m, up from none in one year. However, it does have CN¥99.4m in cash offsetting this, leading to net cash of CN¥84.3m.

How Strong Is NCS Testing Technology's Balance Sheet?

According to the last reported balance sheet, NCS Testing Technology had liabilities of CN¥521.5m due within 12 months, and liabilities of CN¥247.7m due beyond 12 months. Offsetting this, it had CN¥99.4m in cash and CN¥414.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥255.4m.

Of course, NCS Testing Technology has a market capitalization of CN¥5.25b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, NCS Testing Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

See our latest analysis for NCS Testing Technology

On top of that, NCS Testing Technology grew its EBIT by 55% over the last twelve months, and that growth will make it easier to handle its debt. 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 NCS Testing Technology 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. NCS Testing Technology 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, NCS Testing Technology burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

We could understand if investors are concerned about NCS Testing Technology's liabilities, but we can be reassured by the fact it has has net cash of CN¥84.3m. And we liked the look of last year's 55% year-on-year EBIT growth. So we don't have any problem with NCS Testing Technology's use of debt. 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, we've discovered 2 warning signs for NCS Testing Technology that you should be aware of before investing here.

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.