Zhejiang Jinke Tom Culture Industry (SZSE:300459) Takes On Some Risk With Its Use Of Debt

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. We can see that Zhejiang Jinke Tom Culture Industry Co., LTD. (SZSE:300459) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Zhejiang Jinke Tom Culture Industry

What Is Zhejiang Jinke Tom Culture Industry's Debt?

As you can see below, Zhejiang Jinke Tom Culture Industry had CN¥1.61b of debt at September 2024, down from CN¥1.80b a year prior. However, it also had CN¥484.7m in cash, and so its net debt is CN¥1.12b.

How Strong Is Zhejiang Jinke Tom Culture Industry's Balance Sheet?

The latest balance sheet data shows that Zhejiang Jinke Tom Culture Industry had liabilities of CN¥1.50b due within a year, and liabilities of CN¥428.6m falling due after that. Offsetting this, it had CN¥484.7m in cash and CN¥200.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥1.24b more than its cash and near-term receivables, combined.

Of course, Zhejiang Jinke Tom Culture Industry has a market capitalization of CN¥24.3b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Zhejiang Jinke Tom Culture Industry's net debt to EBITDA ratio of 4.7, we think its super-low interest cover of 2.0 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Even worse, Zhejiang Jinke Tom Culture Industry saw its EBIT tank 44% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But it is Zhejiang Jinke Tom Culture Industry's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Zhejiang Jinke Tom Culture Industry generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Neither Zhejiang Jinke Tom Culture Industry's ability to grow its EBIT nor its interest cover gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. We think that Zhejiang Jinke Tom Culture Industry's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Zhejiang Jinke Tom Culture Industry is showing 1 warning sign in our investment analysis , you should know about...

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.

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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.