Does Hangzhou Changchuan TechnologyLtd (SZSE:300604) Have A Healthy Balance Sheet?

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.' 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. As with many other companies Hangzhou Changchuan Technology Co.,Ltd (SZSE:300604) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hangzhou Changchuan TechnologyLtd

How Much Debt Does Hangzhou Changchuan TechnologyLtd Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Hangzhou Changchuan TechnologyLtd had debt of CN¥1.33b, up from CN¥910.3m in one year. On the flip side, it has CN¥1.09b in cash leading to net debt of about CN¥240.8m.

A Look At Hangzhou Changchuan TechnologyLtd's Liabilities

The latest balance sheet data shows that Hangzhou Changchuan TechnologyLtd had liabilities of CN¥2.55b due within a year, and liabilities of CN¥437.6m falling due after that. On the other hand, it had cash of CN¥1.09b and CN¥1.57b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥326.2m.

Having regard to Hangzhou Changchuan TechnologyLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥17.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, Hangzhou Changchuan TechnologyLtd has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Hangzhou Changchuan TechnologyLtd's net debt is only 0.87 times its EBITDA. And its EBIT covers its interest expense a whopping 21.3 times over. So we're pretty relaxed about its super-conservative use of debt. On top of that, Hangzhou Changchuan TechnologyLtd grew its EBIT by 77% 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 ultimately the future profitability of the business will decide if Hangzhou Changchuan TechnologyLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Hangzhou Changchuan TechnologyLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Happily, Hangzhou Changchuan TechnologyLtd's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Hangzhou Changchuan TechnologyLtd can comfortably handle its current debt levels. 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. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Hangzhou Changchuan TechnologyLtd that you should be aware of before investing here.

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.