Is Darbond Technology (SHSE:688035) Using Too Much 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.' 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. We note that Darbond Technology Co., Ltd (SHSE:688035) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Darbond Technology

What Is Darbond Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Darbond Technology had debt of CN¥124.0m, up from CN¥94.1m in one year. However, it does have CN¥708.7m in cash offsetting this, leading to net cash of CN¥584.7m.

How Strong Is Darbond Technology's Balance Sheet?

We can see from the most recent balance sheet that Darbond Technology had liabilities of CN¥377.8m falling due within a year, and liabilities of CN¥76.2m due beyond that. On the other hand, it had cash of CN¥708.7m and CN¥487.4m worth of receivables due within a year. So it actually has CN¥742.0m more liquid assets than total liabilities.

This surplus suggests that Darbond Technology is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Darbond Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Darbond Technology's EBIT dived 18%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Darbond Technology 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. Darbond Technology 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, Darbond Technology 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 Darbond Technology has CN¥584.7m in net cash and a decent-looking balance sheet. So we are not troubled with Darbond Technology's debt use. 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 3 warning signs for Darbond Technology (1 doesn't sit too well with us) you should be aware of.

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.