These 4 Measures Indicate That Guangdong Ellington Electronics TechnologyLtd (SHSE:603328) Is Using Debt Safely

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 Guangdong Ellington Electronics Technology Co.,Ltd (SHSE:603328) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Guangdong Ellington Electronics TechnologyLtd

What Is Guangdong Ellington Electronics TechnologyLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Guangdong Ellington Electronics TechnologyLtd had CN¥209.6m of debt, an increase on CN¥100.2m, over one year. But on the other hand it also has CN¥1.48b in cash, leading to a CN¥1.27b net cash position.

How Healthy Is Guangdong Ellington Electronics TechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Guangdong Ellington Electronics TechnologyLtd had liabilities of CN¥1.39b falling due within a year, and liabilities of CN¥98.5m due beyond that. Offsetting this, it had CN¥1.48b in cash and CN¥1.22b in receivables that were due within 12 months. So it actually has CN¥1.22b more liquid assets than total liabilities.

This surplus suggests that Guangdong Ellington Electronics TechnologyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Guangdong Ellington Electronics TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Guangdong Ellington Electronics TechnologyLtd grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Guangdong Ellington Electronics TechnologyLtd'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Guangdong Ellington Electronics TechnologyLtd 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, Guangdong Ellington Electronics TechnologyLtd produced sturdy free cash flow equating to 76% 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 we empathize with investors who find debt concerning, you should keep in mind that Guangdong Ellington Electronics TechnologyLtd has net cash of CN¥1.27b, as well as more liquid assets than liabilities. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in CN¥167m. So we don't think Guangdong Ellington Electronics TechnologyLtd's use of debt is risky. 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. We've identified 2 warning signs with Guangdong Ellington Electronics TechnologyLtd (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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.