Is Songcheng Performance DevelopmentLtd (SZSE:300144) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Songcheng Performance Development Co.,Ltd (SZSE:300144) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Songcheng Performance DevelopmentLtd

What Is Songcheng Performance DevelopmentLtd's Debt?

As you can see below, Songcheng Performance DevelopmentLtd had CN¥143.1m of debt at March 2024, down from CN¥291.3m a year prior. However, it does have CN¥3.45b in cash offsetting this, leading to net cash of CN¥3.31b.

How Strong Is Songcheng Performance DevelopmentLtd's Balance Sheet?

The latest balance sheet data shows that Songcheng Performance DevelopmentLtd had liabilities of CN¥785.0m due within a year, and liabilities of CN¥779.7m falling due after that. Offsetting this, it had CN¥3.45b in cash and CN¥29.7m in receivables that were due within 12 months. So it can boast CN¥1.92b more liquid assets than total liabilities.

This short term liquidity is a sign that Songcheng Performance DevelopmentLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Songcheng Performance DevelopmentLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Songcheng Performance DevelopmentLtd turned things around in the last 12 months, delivering and EBIT of CN¥1.2b. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Songcheng Performance DevelopmentLtd's ability to maintain a healthy balance sheet going forward. 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. While Songcheng Performance DevelopmentLtd 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. During the last year, Songcheng Performance DevelopmentLtd generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Songcheng Performance DevelopmentLtd has CN¥3.31b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥1.2b, being 96% of its EBIT. So is Songcheng Performance DevelopmentLtd's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Songcheng Performance DevelopmentLtd .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.