Is Suzhou SONAVOX ElectronicsLtd (SHSE:688533) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Suzhou SONAVOX Electronics Co.,Ltd. (SHSE:688533) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Suzhou SONAVOX ElectronicsLtd

What Is Suzhou SONAVOX ElectronicsLtd's Debt?

As you can see below, at the end of September 2024, Suzhou SONAVOX ElectronicsLtd had CN¥977.8m of debt, up from CN¥867.2m a year ago. Click the image for more detail. However, it also had CN¥462.2m in cash, and so its net debt is CN¥515.6m.

A Look At Suzhou SONAVOX ElectronicsLtd's Liabilities

The latest balance sheet data shows that Suzhou SONAVOX ElectronicsLtd had liabilities of CN¥1.10b due within a year, and liabilities of CN¥604.3m falling due after that. Offsetting these obligations, it had cash of CN¥462.2m as well as receivables valued at CN¥992.6m due within 12 months. So its liabilities total CN¥251.1m more than the combination of its cash and short-term receivables.

Of course, Suzhou SONAVOX ElectronicsLtd has a market capitalization of CN¥5.82b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Suzhou SONAVOX ElectronicsLtd's net debt is only 1.4 times its EBITDA. And its EBIT covers its interest expense a whopping 14.2 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that Suzhou SONAVOX ElectronicsLtd grew its EBIT by 130% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Suzhou SONAVOX ElectronicsLtd 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Suzhou SONAVOX ElectronicsLtd 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.

Our View

Suzhou SONAVOX ElectronicsLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that Suzhou SONAVOX ElectronicsLtd can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. For instance, we've identified 3 warning signs for Suzhou SONAVOX ElectronicsLtd (1 is potentially serious) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.