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.' 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 Wuhan Kotei Informatics Co.,Ltd. (SZSE:301221) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Wuhan Kotei InformaticsLtd

What Is Wuhan Kotei InformaticsLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Wuhan Kotei InformaticsLtd had CN¥58.3m of debt, an increase on CN¥26.0m, over one year. But on the other hand it also has CN¥1.20b in cash, leading to a CN¥1.14b net cash position.

A Look At Wuhan Kotei InformaticsLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Wuhan Kotei InformaticsLtd had liabilities of CN¥159.3m due within 12 months and liabilities of CN¥25.9m due beyond that. Offsetting this, it had CN¥1.20b in cash and CN¥356.6m in receivables that were due within 12 months. So it actually has CN¥1.37b 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 110% over twelve months. That boost will make it even easier to pay down debt going forward. 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 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, a company can only pay off debt with cold hard cash, not accounting profits. 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¥1.14b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 110% over the last year. So we don't think Wuhan Kotei InformaticsLtd'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. 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.

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.

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