Shenyang Fortune Precision Equipment (SHSE:688409) Takes On Some Risk With Its Use Of Debt

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Shenyang Fortune Precision Equipment Co., Ltd. (SHSE:688409) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Net Debt?

As you can see below, at the end of March 2024, Shenyang Fortune Precision Equipment had CN¥1.42b of debt, up from CN¥636.9m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.71b in cash, so it actually has CN¥290.1m net cash.

A Look At Shenyang Fortune Precision Equipment's Liabilities

Zooming in on the latest balance sheet data, we can see that Shenyang Fortune Precision Equipment had liabilities of CN¥1.08b due within 12 months and liabilities of CN¥1.76b due beyond that. On the other hand, it had cash of CN¥1.71b and CN¥1.11b worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Shenyang Fortune Precision Equipment's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥13.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Shenyang Fortune Precision Equipment boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Shenyang Fortune Precision Equipment's EBIT dived 19%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shenyang Fortune Precision Equipment 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 company can only pay off debt with cold hard cash, not accounting profits. Shenyang Fortune Precision Equipment 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. 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.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Shenyang Fortune Precision Equipment has CN¥290.1m in net cash. So while Shenyang Fortune Precision Equipment does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Shenyang Fortune Precision Equipment (1 is a bit concerning) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.