Xiamen Jihong Technology (SZSE:002803) Seems To Use Debt Quite Sensibly

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.' 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. Importantly, Xiamen Jihong Technology Co., Ltd. (SZSE:002803) does carry debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Xiamen Jihong Technology

How Much Debt Does Xiamen Jihong Technology Carry?

The chart below, which you can click on for greater detail, shows that Xiamen Jihong Technology had CN¥267.6m in debt in September 2024; about the same as the year before. But it also has CN¥792.9m in cash to offset that, meaning it has CN¥525.3m net cash.

How Healthy Is Xiamen Jihong Technology's Balance Sheet?

According to the last reported balance sheet, Xiamen Jihong Technology had liabilities of CN¥801.6m due within 12 months, and liabilities of CN¥218.7m due beyond 12 months. On the other hand, it had cash of CN¥792.9m and CN¥533.9m worth of receivables due within a year. So it can boast CN¥306.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Xiamen Jihong Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Xiamen Jihong Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Xiamen Jihong Technology's saving grace is its low debt levels, because its EBIT has tanked 62% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Xiamen Jihong 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Xiamen Jihong 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. Happily for any shareholders, Xiamen Jihong Technology actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Xiamen Jihong Technology has CN¥525.3m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 111% of that EBIT to free cash flow, bringing in CN¥424m. So we don't have any problem with Xiamen Jihong Technology's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Xiamen Jihong Technology has 3 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.