These 4 Measures Indicate That Hangzhou First Applied Material (SHSE:603806) Is Using Debt Reasonably Well

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Hangzhou First Applied Material Co., Ltd. (SHSE:603806) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Hangzhou First Applied Material's Debt?

You can click the graphic below for the historical numbers, but it shows that Hangzhou First Applied Material had CN¥3.53b of debt in September 2024, down from CN¥4.52b, one year before. But on the other hand it also has CN¥4.60b in cash, leading to a CN¥1.07b net cash position.

How Strong Is Hangzhou First Applied Material's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hangzhou First Applied Material had liabilities of CN¥1.99b due within 12 months and liabilities of CN¥3.11b due beyond that. On the other hand, it had cash of CN¥4.60b and CN¥7.24b worth of receivables due within a year. So it can boast CN¥6.73b more liquid assets than total liabilities.

It's good to see that Hangzhou First Applied Material has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Hangzhou First Applied Material boasts net cash, so it's fair to say it does not have a heavy debt load!

View our latest analysis for Hangzhou First Applied Material

Also good is that Hangzhou First Applied Material grew its EBIT at 17% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hangzhou First Applied Material's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Hangzhou First Applied 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, Hangzhou First Applied Material's free cash flow amounted to 21% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hangzhou First Applied Material has CN¥1.07b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 17% over the last year. So we don't think Hangzhou First Applied Material's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for Hangzhou First Applied Material you should be aware of.

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.