Here's Why Hygon Information Technology (SHSE:688041) Can Manage Its Debt Responsibly

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Hygon Information Technology Co., Ltd. (SHSE:688041) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Hygon Information Technology

What Is Hygon Information Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Hygon Information Technology had CN¥1.40b of debt, an increase on CN¥1.09b, over one year. However, its balance sheet shows it holds CN¥7.44b in cash, so it actually has CN¥6.04b net cash.

How Healthy Is Hygon Information Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hygon Information Technology had liabilities of CN¥1.82b due within 12 months and liabilities of CN¥1.32b due beyond that. On the other hand, it had cash of CN¥7.44b and CN¥1.54b worth of receivables due within a year. So it can boast CN¥5.85b more liquid assets than total liabilities.

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

On top of that, Hygon Information Technology grew its EBIT by 53% over the last twelve months, and that growth will make it easier to handle its debt. 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 Hygon Information 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. Hygon Information Technology 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. During the last three years, Hygon Information Technology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hygon Information Technology has net cash of CN¥6.04b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 53% over the last year. So we are not troubled with Hygon Information Technology's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Hygon Information Technology you should know about.

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.