We Think Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou (SZSE:000523) 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Hongmian Zhihui Science and Technology Innovation Co.,Ltd.Guangzhou (SZSE:000523) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou

What Is Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou's Net Debt?

As you can see below, at the end of September 2024, Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou had CN¥283.0m of debt, up from CN¥193.1m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.07b in cash, so it actually has CN¥790.2m net cash.

How Healthy Is Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou's Balance Sheet?

We can see from the most recent balance sheet that Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou had liabilities of CN¥596.2m falling due within a year, and liabilities of CN¥1.21b due beyond that. Offsetting these obligations, it had cash of CN¥1.07b as well as receivables valued at CN¥276.3m due within 12 months. So it has liabilities totalling CN¥460.4m more than its cash and near-term receivables, combined.

Of course, Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou has a market capitalization of CN¥5.23b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou made a loss at the EBIT level, last year, it was also good to see that it generated CN¥110m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou 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. During the last year, Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou has CN¥790.2m in net cash. So we are not troubled with Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou you should be aware of.

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.

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.