Does Shenzhen Gongjin Electronics (SHSE:603118) Have A Healthy Balance Sheet?

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. Importantly, Shenzhen Gongjin Electronics Co., Ltd. (SHSE:603118) does carry debt. But is this debt a concern to shareholders?

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

See our latest analysis for Shenzhen Gongjin Electronics

How Much Debt Does Shenzhen Gongjin Electronics Carry?

The image below, which you can click on for greater detail, shows that Shenzhen Gongjin Electronics had debt of CN¥881.9m at the end of June 2024, a reduction from CN¥1.69b over a year. But on the other hand it also has CN¥2.01b in cash, leading to a CN¥1.13b net cash position.

A Look At Shenzhen Gongjin Electronics' Liabilities

According to the last reported balance sheet, Shenzhen Gongjin Electronics had liabilities of CN¥3.59b due within 12 months, and liabilities of CN¥167.0m due beyond 12 months. On the other hand, it had cash of CN¥2.01b and CN¥1.89b worth of receivables due within a year. So it actually has CN¥146.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Shenzhen Gongjin Electronics could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Shenzhen Gongjin Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Shenzhen Gongjin Electronics if management cannot prevent a repeat of the 93% cut to EBIT 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 Shenzhen Gongjin Electronics'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, a company can only pay off debt with cold hard cash, not accounting profits. Shenzhen Gongjin Electronics 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. In the last three years, Shenzhen Gongjin Electronics's free cash flow amounted to 45% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Gongjin Electronics has net cash of CN¥1.13b, as well as more liquid assets than liabilities. So we are not troubled with Shenzhen Gongjin Electronics's debt use. 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. For example, we've discovered 3 warning signs for Shenzhen Gongjin Electronics that you should be aware of before investing here.

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.