Innuovo Technology (SZSE:000795) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Innuovo Technology Co., Ltd. (SZSE:000795) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Innuovo Technology

How Much Debt Does Innuovo Technology Carry?

The image below, which you can click on for greater detail, shows that Innuovo Technology had debt of CN¥424.6m at the end of March 2024, a reduction from CN¥1.39b over a year. But on the other hand it also has CN¥673.1m in cash, leading to a CN¥248.5m net cash position.

How Healthy Is Innuovo Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Innuovo Technology had liabilities of CN¥1.25b due within 12 months and liabilities of CN¥71.6m due beyond that. On the other hand, it had cash of CN¥673.1m and CN¥1.05b worth of receivables due within a year. So it can boast CN¥397.5m more liquid assets than total liabilities.

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

It is just as well that Innuovo Technology's load is not too heavy, because its EBIT was down 31% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Innuovo Technology will need earnings to service that debt. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Innuovo Technology has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Innuovo Technology created free cash flow amounting to 6.2% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Innuovo Technology has net cash of CN¥248.5m, as well as more liquid assets than liabilities. So we are not troubled with Innuovo Technology'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. To that end, you should be aware of the 1 warning sign we've spotted with Innuovo Technology .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

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