Does Sichuan Changhong ElectricLtd (SHSE:600839) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Sichuan Changhong Electric Co.,Ltd. (SHSE:600839) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Sichuan Changhong ElectricLtd

What Is Sichuan Changhong ElectricLtd's Debt?

The chart below, which you can click on for greater detail, shows that Sichuan Changhong ElectricLtd had CN¥18.5b in debt in June 2024; about the same as the year before. But on the other hand it also has CN¥27.1b in cash, leading to a CN¥8.64b net cash position.

A Look At Sichuan Changhong ElectricLtd's Liabilities

According to the last reported balance sheet, Sichuan Changhong ElectricLtd had liabilities of CN¥66.2b due within 12 months, and liabilities of CN¥4.59b due beyond 12 months. Offsetting these obligations, it had cash of CN¥27.1b as well as receivables valued at CN¥19.4b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥24.3b.

This deficit is considerable relative to its market capitalization of CN¥27.3b, so it does suggest shareholders should keep an eye on Sichuan Changhong ElectricLtd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Sichuan Changhong ElectricLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Sichuan Changhong ElectricLtd's EBIT dived 18%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sichuan Changhong ElectricLtd 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. While Sichuan Changhong ElectricLtd 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. Happily for any shareholders, Sichuan Changhong ElectricLtd actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While Sichuan Changhong ElectricLtd does have more liabilities than liquid assets, it also has net cash of CN¥8.64b. And it impressed us with free cash flow of CN¥1.2b, being 201% of its EBIT. So we are not troubled with Sichuan Changhong ElectricLtd's debt use. 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 instance, we've identified 2 warning signs for Sichuan Changhong ElectricLtd that you should be aware of.

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.