Here's Why Wuhan Kotei InformaticsLtd (SZSE:301221) Can Manage Its Debt Responsibly

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Wuhan Kotei Informatics Co.,Ltd. (SZSE:301221) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Wuhan Kotei InformaticsLtd

What Is Wuhan Kotei InformaticsLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Wuhan Kotei InformaticsLtd had debt of CN¥77.4m, up from CN¥36.4m in one year. But it also has CN¥1.32b in cash to offset that, meaning it has CN¥1.24b net cash.

How Healthy Is Wuhan Kotei InformaticsLtd's Balance Sheet?

We can see from the most recent balance sheet that Wuhan Kotei InformaticsLtd had liabilities of CN¥226.5m falling due within a year, and liabilities of CN¥21.2m due beyond that. Offsetting these obligations, it had cash of CN¥1.32b as well as receivables valued at CN¥335.7m due within 12 months. So it actually has CN¥1.41b more liquid assets than total liabilities.

This luscious liquidity implies that Wuhan Kotei InformaticsLtd's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Wuhan Kotei InformaticsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Wuhan Kotei InformaticsLtd grew its EBIT by 991% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Wuhan Kotei InformaticsLtd 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Wuhan Kotei InformaticsLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Wuhan Kotei InformaticsLtd saw substantial negative free cash flow, in total. 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 Wuhan Kotei InformaticsLtd has CN¥1.24b in net cash and a decent-looking balance sheet. And we liked the look of last year's 991% year-on-year EBIT growth. So is Wuhan Kotei InformaticsLtd'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. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Wuhan Kotei InformaticsLtd you should know about.

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.