Beijing Yuanliu Hongyuan Electronic Technology (SHSE:603267) Seems To Use Debt Quite Sensibly

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. We can see that Beijing Yuanliu Hongyuan Electronic Technology Co., Ltd. (SHSE:603267) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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.

Check out our latest analysis for Beijing Yuanliu Hongyuan Electronic Technology

How Much Debt Does Beijing Yuanliu Hongyuan Electronic Technology Carry?

As you can see below, Beijing Yuanliu Hongyuan Electronic Technology had CN¥170.6m of debt at September 2024, down from CN¥569.4m a year prior. However, it does have CN¥1.25b in cash offsetting this, leading to net cash of CN¥1.08b.

How Strong Is Beijing Yuanliu Hongyuan Electronic Technology's Balance Sheet?

According to the last reported balance sheet, Beijing Yuanliu Hongyuan Electronic Technology had liabilities of CN¥417.7m due within 12 months, and liabilities of CN¥81.4m due beyond 12 months. On the other hand, it had cash of CN¥1.25b and CN¥1.56b worth of receivables due within a year. So it actually has CN¥2.31b more liquid assets than total liabilities.

This surplus suggests that Beijing Yuanliu Hongyuan Electronic Technology is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Beijing Yuanliu Hongyuan Electronic Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Beijing Yuanliu Hongyuan Electronic Technology's saving grace is its low debt levels, because its EBIT has tanked 68% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Beijing Yuanliu Hongyuan Electronic Technology'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Beijing Yuanliu Hongyuan Electronic Technology 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. During the last three years, Beijing Yuanliu Hongyuan Electronic Technology produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Beijing Yuanliu Hongyuan Electronic Technology has CN¥1.08b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥595m, being 72% of its EBIT. So we don't have any problem with Beijing Yuanliu Hongyuan Electronic Technology's use of debt. 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. For example - Beijing Yuanliu Hongyuan Electronic Technology has 2 warning signs we think you should be aware of.

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.