Here's Why Xiangtan Electrochemical ScientificLtd (SZSE:002125) Can Manage Its Debt Responsibly

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.' 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 note that Xiangtan Electrochemical Scientific Co.,Ltd (SZSE:002125) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, 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 Xiangtan Electrochemical ScientificLtd

What Is Xiangtan Electrochemical ScientificLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Xiangtan Electrochemical ScientificLtd had CN¥1.45b of debt in June 2024, down from CN¥1.85b, one year before. On the flip side, it has CN¥400.3m in cash leading to net debt of about CN¥1.05b.

How Strong Is Xiangtan Electrochemical ScientificLtd's Balance Sheet?

We can see from the most recent balance sheet that Xiangtan Electrochemical ScientificLtd had liabilities of CN¥1.10b falling due within a year, and liabilities of CN¥888.0m due beyond that. On the other hand, it had cash of CN¥400.3m and CN¥550.5m worth of receivables due within a year. So its liabilities total CN¥1.04b more than the combination of its cash and short-term receivables.

Since publicly traded Xiangtan Electrochemical ScientificLtd shares are worth a total of CN¥5.62b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Xiangtan Electrochemical ScientificLtd's net debt to EBITDA ratio of about 1.8 suggests only moderate use of debt. And its strong interest cover of 1k times, makes us even more comfortable. Pleasingly, Xiangtan Electrochemical ScientificLtd is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 585% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Xiangtan Electrochemical ScientificLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Xiangtan Electrochemical ScientificLtd recorded free cash flow worth 50% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Xiangtan Electrochemical ScientificLtd's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! When we consider the range of factors above, it looks like Xiangtan Electrochemical ScientificLtd is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Xiangtan Electrochemical ScientificLtd , and understanding them should be part of your investment process.

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.