Is Shenzhen Gongjin Electronics (SHSE:603118) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Shenzhen Gongjin Electronics Co., Ltd. (SHSE:603118) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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

What Is Shenzhen Gongjin Electronics's Debt?

As you can see below, Shenzhen Gongjin Electronics had CN¥450.1m of debt at September 2024, down from CN¥1.60b a year prior. However, it does have CN¥2.05b in cash offsetting this, leading to net cash of CN¥1.60b.

How Strong Is Shenzhen Gongjin Electronics' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen Gongjin Electronics had liabilities of CN¥4.14b due within 12 months and liabilities of CN¥159.1m due beyond that. Offsetting these obligations, it had cash of CN¥2.05b as well as receivables valued at CN¥2.08b due within 12 months. So it has liabilities totalling CN¥171.2m more than its cash and near-term receivables, combined.

Since publicly traded Shenzhen Gongjin Electronics shares are worth a total of CN¥7.27b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Shenzhen Gongjin Electronics also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Shenzhen Gongjin Electronics's saving grace is its low debt levels, because its EBIT has tanked 71% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shenzhen Gongjin Electronics's ability to maintain a healthy balance sheet going forward. 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 Shenzhen Gongjin Electronics 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, Shenzhen Gongjin Electronics recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Shenzhen Gongjin Electronics has CN¥1.60b in net cash. So although we see some areas for improvement, we're not too worried about Shenzhen Gongjin Electronics's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Shenzhen Gongjin Electronics you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.