Here's Why Wuxi Paike New Materials TechnologyLtd (SHSE:605123) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Wuxi Paike New Materials Technology Co.,Ltd. (SHSE:605123) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Wuxi Paike New Materials TechnologyLtd

What Is Wuxi Paike New Materials TechnologyLtd's Net Debt?

As you can see below, Wuxi Paike New Materials TechnologyLtd had CN¥435.6m of debt at June 2024, down from CN¥470.3m a year prior. But on the other hand it also has CN¥1.98b in cash, leading to a CN¥1.55b net cash position.

How Strong Is Wuxi Paike New Materials TechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Wuxi Paike New Materials TechnologyLtd had liabilities of CN¥2.21b falling due within a year, and liabilities of CN¥291.9m due beyond that. On the other hand, it had cash of CN¥1.98b and CN¥2.03b worth of receivables due within a year. So it actually has CN¥1.51b more liquid assets than total liabilities.

This surplus suggests that Wuxi Paike New Materials TechnologyLtd is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Wuxi Paike New Materials TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Wuxi Paike New Materials TechnologyLtd's load is not too heavy, because its EBIT was down 38% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Wuxi Paike New Materials TechnologyLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Wuxi Paike New Materials 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. During the last three years, Wuxi Paike New Materials TechnologyLtd 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 investigate a company's debt, in this case Wuxi Paike New Materials TechnologyLtd has CN¥1.55b in net cash and a decent-looking balance sheet. So we don't have any problem with Wuxi Paike New Materials TechnologyLtd's use of debt. 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. To that end, you should be aware of the 2 warning signs we've spotted with Wuxi Paike New Materials TechnologyLtd .

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.

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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.