Huakai Yibai TechnologyLtd (SZSE:300592) Could Easily Take On More Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Huakai Yibai Technology Co.,Ltd. (SZSE:300592) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 Huakai Yibai TechnologyLtd

What Is Huakai Yibai TechnologyLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Huakai Yibai TechnologyLtd had CN¥220.7m of debt, an increase on CN¥71.5m, over one year. However, it does have CN¥694.1m in cash offsetting this, leading to net cash of CN¥473.4m.

How Strong Is Huakai Yibai TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Huakai Yibai TechnologyLtd had liabilities of CN¥781.4m due within 12 months and liabilities of CN¥454.6m due beyond that. Offsetting this, it had CN¥694.1m in cash and CN¥584.3m in receivables that were due within 12 months. So it actually has CN¥42.4m more liquid assets than total liabilities.

Having regard to Huakai Yibai TechnologyLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥5.04b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Huakai Yibai TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Huakai Yibai TechnologyLtd grew its EBIT at 15% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Huakai Yibai TechnologyLtd'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. Huakai Yibai TechnologyLtd 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. Happily for any shareholders, Huakai Yibai TechnologyLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Huakai Yibai TechnologyLtd has net cash of CN¥473.4m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥187m, being 125% of its EBIT. So we don't think Huakai Yibai TechnologyLtd's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Huakai Yibai TechnologyLtd 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.