Sokan New Materials Group (SHSE:688157) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Sokan New Materials Group Co., Ltd. (SHSE:688157) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. 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.

Check out our latest analysis for Sokan New Materials Group

What Is Sokan New Materials Group's Net Debt?

As you can see below, at the end of March 2024, Sokan New Materials Group had CN¥124.8m of debt, up from CN¥397.0k a year ago. Click the image for more detail. But it also has CN¥295.8m in cash to offset that, meaning it has CN¥171.0m net cash.

A Look At Sokan New Materials Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Sokan New Materials Group had liabilities of CN¥268.6m due within 12 months and liabilities of CN¥31.3m due beyond that. On the other hand, it had cash of CN¥295.8m and CN¥343.7m worth of receivables due within a year. So it can boast CN¥339.7m more liquid assets than total liabilities.

This surplus suggests that Sokan New Materials Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Sokan New Materials Group has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Sokan New Materials Group has boosted its EBIT by 88%, thus reducing the spectre of future debt repayments. 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 Sokan New Materials Group 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 company can only pay off debt with cold hard cash, not accounting profits. Sokan New Materials Group 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. Over the last three years, Sokan New Materials Group saw substantial negative free cash flow, in total. 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 Sokan New Materials Group has CN¥171.0m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 88% over the last year. So we are not troubled with Sokan New Materials Group's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Sokan New Materials Group .

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.