Is Shanghai Flyco Electrical Appliance (SHSE:603868) 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.' 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. Importantly, Shanghai Flyco Electrical Appliance Co., Ltd. (SHSE:603868) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shanghai Flyco Electrical Appliance

How Much Debt Does Shanghai Flyco Electrical Appliance Carry?

As you can see below, at the end of September 2024, Shanghai Flyco Electrical Appliance had CN¥430.0m of debt, up from none a year ago. Click the image for more detail. But it also has CN¥1.62b in cash to offset that, meaning it has CN¥1.19b net cash.

A Look At Shanghai Flyco Electrical Appliance's Liabilities

We can see from the most recent balance sheet that Shanghai Flyco Electrical Appliance had liabilities of CN¥1.09b falling due within a year, and liabilities of CN¥101.3m due beyond that. Offsetting these obligations, it had cash of CN¥1.62b as well as receivables valued at CN¥294.1m due within 12 months. So it can boast CN¥723.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Shanghai Flyco Electrical Appliance could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shanghai Flyco Electrical Appliance boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Shanghai Flyco Electrical Appliance's load is not too heavy, because its EBIT was down 40% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shanghai Flyco Electrical Appliance 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 Flyco Electrical Appliance 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 three years, Shanghai Flyco Electrical Appliance generated free cash flow amounting to a very robust 94% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shanghai Flyco Electrical Appliance has CN¥1.19b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥333m, being 94% of its EBIT. So we are not troubled with Shanghai Flyco Electrical Appliance's debt use. 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. For example, we've discovered 2 warning signs for Shanghai Flyco Electrical Appliance (1 can't be ignored!) that you should be aware of before investing here.

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.