Is WuXi Xinje ElectricLtd (SHSE:603416) Using Too Much Debt?

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.' 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 WuXi Xinje Electric Co.,Ltd. (SHSE:603416) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for WuXi Xinje ElectricLtd

What Is WuXi Xinje ElectricLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 WuXi Xinje ElectricLtd had CN¥33.0m of debt, an increase on CN¥20.0m, over one year. However, its balance sheet shows it holds CN¥1.14b in cash, so it actually has CN¥1.11b net cash.

How Healthy Is WuXi Xinje ElectricLtd's Balance Sheet?

The latest balance sheet data shows that WuXi Xinje ElectricLtd had liabilities of CN¥799.9m due within a year, and liabilities of CN¥32.2m falling due after that. On the other hand, it had cash of CN¥1.14b and CN¥511.1m worth of receivables due within a year. So it actually has CN¥818.4m more liquid assets than total liabilities.

This surplus suggests that WuXi Xinje ElectricLtd 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 WuXi Xinje ElectricLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Also positive, WuXi Xinje ElectricLtd grew its EBIT by 21% 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 ultimately the future profitability of the business will decide if WuXi Xinje ElectricLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. WuXi Xinje ElectricLtd 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. During the last three years, WuXi Xinje ElectricLtd produced sturdy free cash flow equating to 51% 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 WuXi Xinje ElectricLtd has CN¥1.11b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 21% over the last year. So is WuXi Xinje ElectricLtd's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with WuXi Xinje ElectricLtd (at least 1 which shouldn't be ignored) , 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.