Does Shenzhen Kinwong Electronic (SHSE:603228) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that Shenzhen Kinwong Electronic Co., Ltd. (SHSE:603228) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Shenzhen Kinwong Electronic

What Is Shenzhen Kinwong Electronic's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Shenzhen Kinwong Electronic had debt of CN¥3.44b, up from CN¥2.50b in one year. However, because it has a cash reserve of CN¥2.54b, its net debt is less, at about CN¥901.1m.

How Strong Is Shenzhen Kinwong Electronic's Balance Sheet?

The latest balance sheet data shows that Shenzhen Kinwong Electronic had liabilities of CN¥4.72b due within a year, and liabilities of CN¥3.45b falling due after that. Offsetting this, it had CN¥2.54b in cash and CN¥4.72b in receivables that were due within 12 months. So it has liabilities totalling CN¥908.2m more than its cash and near-term receivables, combined.

Given Shenzhen Kinwong Electronic has a market capitalization of CN¥21.9b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Shenzhen Kinwong Electronic has a low net debt to EBITDA ratio of only 0.47. And its EBIT easily covers its interest expense, being 695 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. While Shenzhen Kinwong Electronic doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 Shenzhen Kinwong Electronic 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. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Shenzhen Kinwong Electronic 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.

Our View

Based on what we've seen Shenzhen Kinwong Electronic is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Shenzhen Kinwong Electronic's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Shenzhen Kinwong Electronic is showing 1 warning sign in our investment analysis , 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.