Here's Why Xiamen Faratronic (SHSE:600563) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Xiamen Faratronic Co., Ltd. (SHSE:600563) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Xiamen Faratronic

What Is Xiamen Faratronic's Net Debt?

The image below, which you can click on for greater detail, shows that Xiamen Faratronic had debt of CN¥27.3m at the end of September 2024, a reduction from CN¥40.6m over a year. However, its balance sheet shows it holds CN¥1.97b in cash, so it actually has CN¥1.95b net cash.

A Look At Xiamen Faratronic's Liabilities

The latest balance sheet data shows that Xiamen Faratronic had liabilities of CN¥1.97b due within a year, and liabilities of CN¥214.6m falling due after that. Offsetting these obligations, it had cash of CN¥1.97b as well as receivables valued at CN¥2.12b due within 12 months. So it can boast CN¥1.90b more liquid assets than total liabilities.

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

The good news is that Xiamen Faratronic has increased its EBIT by 3.9% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Xiamen Faratronic 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Xiamen Faratronic 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 most recent three years, Xiamen Faratronic recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Xiamen Faratronic has net cash of CN¥1.95b, as well as more liquid assets than liabilities. So we don't think Xiamen Faratronic's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Xiamen Faratronic's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.