We Think Shanghai Aohua Photoelectricity Endoscope (SHSE:688212) Can Stay On Top Of Its 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.' 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 Shanghai Aohua Photoelectricity Endoscope Co., Ltd. (SHSE:688212) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Shanghai Aohua Photoelectricity Endoscope

What Is Shanghai Aohua Photoelectricity Endoscope's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Shanghai Aohua Photoelectricity Endoscope had CN¥43.4m of debt, an increase on none, over one year. But on the other hand it also has CN¥390.1m in cash, leading to a CN¥346.8m net cash position.

How Strong Is Shanghai Aohua Photoelectricity Endoscope's Balance Sheet?

According to the last reported balance sheet, Shanghai Aohua Photoelectricity Endoscope had liabilities of CN¥159.1m due within 12 months, and liabilities of CN¥70.3m due beyond 12 months. On the other hand, it had cash of CN¥390.1m and CN¥295.8m worth of receivables due within a year. So it can boast CN¥456.6m more liquid assets than total liabilities.

This surplus suggests that Shanghai Aohua Photoelectricity Endoscope has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shanghai Aohua Photoelectricity Endoscope has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Shanghai Aohua Photoelectricity Endoscope if management cannot prevent a repeat of the 61% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Shanghai Aohua Photoelectricity Endoscope's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shanghai Aohua Photoelectricity Endoscope 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 last three years, Shanghai Aohua Photoelectricity Endoscope 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shanghai Aohua Photoelectricity Endoscope has CN¥346.8m in net cash and a decent-looking balance sheet. So we are not troubled with Shanghai Aohua Photoelectricity Endoscope's debt use. 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. Be aware that Shanghai Aohua Photoelectricity Endoscope is showing 4 warning signs in our investment analysis , and 2 of those don't sit too well with us...

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.