These 4 Measures Indicate That Northking Information Technology (SZSE:002987) Is Using Debt Reasonably Well

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. Importantly, Northking Information Technology Co., Ltd. (SZSE:002987) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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

See our latest analysis for Northking Information Technology

What Is Northking Information Technology's Debt?

As you can see below, Northking Information Technology had CN¥180.1m of debt at September 2023, down from CN¥197.1m a year prior. But it also has CN¥426.9m in cash to offset that, meaning it has CN¥246.8m net cash.

How Healthy Is Northking Information Technology's Balance Sheet?

We can see from the most recent balance sheet that Northking Information Technology had liabilities of CN¥546.9m falling due within a year, and liabilities of CN¥21.8m due beyond that. Offsetting these obligations, it had cash of CN¥426.9m as well as receivables valued at CN¥2.11b due within 12 months. So it actually has CN¥1.97b more liquid assets than total liabilities.

It's good to see that Northking Information Technology has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Northking Information Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Northking Information Technology has boosted its EBIT by 45%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Northking Information Technology's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Northking 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, Northking Information Technology burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Northking Information Technology has CN¥246.8m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 45% over the last year. So is Northking Information Technology's debt a risk? It doesn't seem so to us. 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. Be aware that Northking Information Technology is showing 1 warning sign in our investment analysis , you should know about...

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.