Is Pony Testing (SZSE:300887) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Pony Testing Co., Ltd. (SZSE:300887) makes use of debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Pony Testing

How Much Debt Does Pony Testing Carry?

The image below, which you can click on for greater detail, shows that Pony Testing had debt of CN¥151.3m at the end of September 2023, a reduction from CN¥236.1m over a year. But on the other hand it also has CN¥1.03b in cash, leading to a CN¥877.7m net cash position.

How Strong Is Pony Testing's Balance Sheet?

According to the last reported balance sheet, Pony Testing had liabilities of CN¥708.9m due within 12 months, and liabilities of CN¥146.5m due beyond 12 months. Offsetting this, it had CN¥1.03b in cash and CN¥1.10b in receivables that were due within 12 months. So it actually has CN¥1.28b more liquid assets than total liabilities.

It's good to see that Pony Testing has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Pony Testing has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Pony Testing saw its EBIT decline by 8.7% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Pony Testing can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Pony Testing 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. Over the last three years, Pony Testing saw substantial negative free cash flow, in total. 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 Pony Testing has net cash of CN¥877.7m, as well as more liquid assets than liabilities. So we are not troubled with Pony Testing's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Pony Testing .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.