Does Grace Fabric TechnologyLtd (SHSE:603256) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Grace Fabric Technology Co.,Ltd. (SHSE:603256) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Grace Fabric TechnologyLtd

What Is Grace Fabric TechnologyLtd's Debt?

As you can see below, at the end of September 2024, Grace Fabric TechnologyLtd had CN¥936.1m of debt, up from CN¥869.7m a year ago. Click the image for more detail. However, it also had CN¥293.5m in cash, and so its net debt is CN¥642.6m.

How Healthy Is Grace Fabric TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Grace Fabric TechnologyLtd had liabilities of CN¥606.2m due within 12 months, and liabilities of CN¥524.9m due beyond 12 months. Offsetting this, it had CN¥293.5m in cash and CN¥432.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥405.5m more than its cash and near-term receivables, combined.

Since publicly traded Grace Fabric TechnologyLtd shares are worth a total of CN¥7.74b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.097 times and a disturbingly high net debt to EBITDA ratio of 5.9 hit our confidence in Grace Fabric TechnologyLtd like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that Grace Fabric TechnologyLtd achieved a positive EBIT of CN¥3.1m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Grace Fabric TechnologyLtd can strengthen its balance sheet over time. 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. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Grace Fabric TechnologyLtd actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

We weren't impressed with Grace Fabric TechnologyLtd's net debt to EBITDA, and its interest cover made us cautious. But its conversion of EBIT to free cash flow was significantly redeeming. Considering this range of data points, we think Grace Fabric TechnologyLtd is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. For instance, we've identified 1 warning sign for Grace Fabric TechnologyLtd that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.