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

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that Pony Testing Co., Ltd. (SZSE:300887) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Pony Testing

What Is Pony Testing's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Pony Testing had debt of CN¥174.7m, up from CN¥86.8m in one year. However, it does have CN¥1.07b in cash offsetting this, leading to net cash of CN¥897.3m.

How Healthy Is Pony Testing's Balance Sheet?

The latest balance sheet data shows that Pony Testing had liabilities of CN¥715.9m due within a year, and liabilities of CN¥92.5m falling due after that. Offsetting these obligations, it had cash of CN¥1.07b as well as receivables valued at CN¥972.1m due within 12 months. So it can boast CN¥1.24b 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. Succinctly put, Pony Testing 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 Pony Testing if management cannot prevent a repeat of the 84% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Pony Testing 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 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¥897.3m, as well as more liquid assets than liabilities. So we don't have any problem with Pony Testing'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 Pony Testing has 4 warning signs (and 2 which can't be ignored) we think you should know about.

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.