Does Shenyang Fortune Precision Equipment (SHSE:688409) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Shenyang Fortune Precision Equipment Co., Ltd. (SHSE:688409) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 Shenyang Fortune Precision Equipment

What Is Shenyang Fortune Precision Equipment's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shenyang Fortune Precision Equipment had CN¥1.76b of debt, an increase on CN¥1.19b, over one year. However, it also had CN¥1.28b in cash, and so its net debt is CN¥486.4m.

How Strong Is Shenyang Fortune Precision Equipment's Balance Sheet?

We can see from the most recent balance sheet that Shenyang Fortune Precision Equipment had liabilities of CN¥1.39b falling due within a year, and liabilities of CN¥1.94b due beyond that. Offsetting these obligations, it had cash of CN¥1.28b as well as receivables valued at CN¥1.47b due within 12 months. So it has liabilities totalling CN¥586.0m more than its cash and near-term receivables, combined.

Since publicly traded Shenyang Fortune Precision Equipment shares are worth a total of CN¥15.9b, it seems unlikely that this level of liabilities would be a major threat. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shenyang Fortune Precision Equipment's net debt is only 1.1 times its EBITDA. And its EBIT easily covers its interest expense, being 23.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Shenyang Fortune Precision Equipment grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its debt. 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 Shenyang Fortune Precision Equipment'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Shenyang Fortune Precision Equipment saw substantial negative free cash flow, in total. 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.

Our View

Shenyang Fortune Precision Equipment's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that Shenyang Fortune Precision Equipment can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. For example Shenyang Fortune Precision Equipment has 3 warning signs (and 1 which is concerning) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.