Is Genimous Technology (SZSE:000676) Using Too Much 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.' 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. As with many other companies Genimous Technology Co., Ltd. (SZSE:000676) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Genimous Technology

What Is Genimous Technology's Net Debt?

As you can see below, Genimous Technology had CN¥244.8m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥1.35b in cash to offset that, meaning it has CN¥1.11b net cash.

How Strong Is Genimous Technology's Balance Sheet?

The latest balance sheet data shows that Genimous Technology had liabilities of CN¥921.6m due within a year, and liabilities of CN¥47.4m falling due after that. On the other hand, it had cash of CN¥1.35b and CN¥873.3m worth of receivables due within a year. So it actually has CN¥1.25b more liquid assets than total liabilities.

This short term liquidity is a sign that Genimous Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Genimous Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Genimous Technology grew its EBIT by 50% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Genimous Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Genimous 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. Over the last two years, Genimous Technology actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Genimous Technology has net cash of CN¥1.11b, as well as more liquid assets than liabilities. The cherry on top was that in converted 399% of that EBIT to free cash flow, bringing in -CN¥275m. So we don't think Genimous Technology'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 2 warning signs for Genimous Technology 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.