Is Shanghai Yaoji Technology (SZSE:002605) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Shanghai Yaoji Technology Co., Ltd. (SZSE:002605) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shanghai Yaoji Technology

What Is Shanghai Yaoji Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Shanghai Yaoji Technology had CN¥805.7m of debt, an increase on CN¥495.3m, over one year. However, it does have CN¥873.4m in cash offsetting this, leading to net cash of CN¥67.7m.

How Strong Is Shanghai Yaoji Technology's Balance Sheet?

According to the last reported balance sheet, Shanghai Yaoji Technology had liabilities of CN¥1.04b due within 12 months, and liabilities of CN¥664.4m due beyond 12 months. On the other hand, it had cash of CN¥873.4m and CN¥721.0m worth of receivables due within a year. So it has liabilities totalling CN¥106.9m more than its cash and near-term receivables, combined.

This state of affairs indicates that Shanghai Yaoji Technology's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥10.7b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Shanghai Yaoji Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Shanghai Yaoji Technology's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Shanghai Yaoji Technology 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shanghai Yaoji Technology 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 most recent three years, Shanghai Yaoji Technology recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Shanghai Yaoji Technology has CN¥67.7m in net cash. So we don't have any problem with Shanghai Yaoji 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 1 warning sign for Shanghai Yaoji Technology that you should be aware of before investing here.

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.