Is Beijing Advanced Digital Technology (SZSE:300541) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Beijing Advanced Digital Technology Co., Ltd (SZSE:300541) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Beijing Advanced Digital Technology

How Much Debt Does Beijing Advanced Digital Technology Carry?

As you can see below, at the end of June 2024, Beijing Advanced Digital Technology had CN¥362.5m of debt, up from CN¥200.7m a year ago. Click the image for more detail. However, it does have CN¥313.7m in cash offsetting this, leading to net debt of about CN¥48.8m.

How Healthy Is Beijing Advanced Digital Technology's Balance Sheet?

According to the last reported balance sheet, Beijing Advanced Digital Technology had liabilities of CN¥976.7m due within 12 months, and liabilities of CN¥5.53m due beyond 12 months. Offsetting this, it had CN¥313.7m in cash and CN¥933.5m in receivables that were due within 12 months. So it actually has CN¥264.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Beijing Advanced Digital Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. But either way, Beijing Advanced Digital Technology 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).

Beijing Advanced Digital Technology has a low net debt to EBITDA ratio of only 0.39. And its EBIT covers its interest expense a whopping 15.0 times over. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Beijing Advanced Digital Technology's load is not too heavy, because its EBIT was down 42% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Beijing Advanced Digital 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Beijing Advanced Digital Technology recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that Beijing Advanced Digital Technology's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its EBIT growth rate has the opposite effect. All these things considered, it appears that Beijing Advanced Digital Technology can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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 4 warning signs for Beijing Advanced Digital Technology you should be aware of, and 1 of them is a bit unpleasant.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.