Puyang Huicheng Electronic Material (SZSE:300481) Seems To Use Debt Quite Sensibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Puyang Huicheng Electronic Material Co., Ltd. (SZSE:300481) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Puyang Huicheng Electronic Material

What Is Puyang Huicheng Electronic Material's Net Debt?

The image below, which you can click on for greater detail, shows that Puyang Huicheng Electronic Material had debt of CN¥228.6m at the end of September 2024, a reduction from CN¥277.2m over a year. However, it does have CN¥966.5m in cash offsetting this, leading to net cash of CN¥737.9m.

A Look At Puyang Huicheng Electronic Material's Liabilities

We can see from the most recent balance sheet that Puyang Huicheng Electronic Material had liabilities of CN¥384.2m falling due within a year, and liabilities of CN¥44.8m due beyond that. Offsetting this, it had CN¥966.5m in cash and CN¥440.2m in receivables that were due within 12 months. So it actually has CN¥977.6m more liquid assets than total liabilities.

This surplus suggests that Puyang Huicheng Electronic Material 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, Puyang Huicheng Electronic Material boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Puyang Huicheng Electronic Material's load is not too heavy, because its EBIT was down 42% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Puyang Huicheng Electronic Material's ability to maintain a healthy balance sheet going forward. 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. Puyang Huicheng Electronic Material 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. In the last three years, Puyang Huicheng Electronic Material's free cash flow amounted to 37% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Puyang Huicheng Electronic Material has net cash of CN¥737.9m, as well as more liquid assets than liabilities. So we are not troubled with Puyang Huicheng Electronic Material's debt use. 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. We've identified 2 warning signs with Puyang Huicheng Electronic Material , and understanding them should be part of your investment process.

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.