Here's Why EmbedWay Technologies (Shanghai) (SHSE:603496) Can Manage Its Debt Responsibly

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.' 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. As with many other companies EmbedWay Technologies (Shanghai) Corporation (SHSE:603496) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. 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 EmbedWay Technologies (Shanghai)

What Is EmbedWay Technologies (Shanghai)'s Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 EmbedWay Technologies (Shanghai) had CN¥240.0m of debt, an increase on CN¥214.4m, over one year. However, its balance sheet shows it holds CN¥467.3m in cash, so it actually has CN¥227.4m net cash.

A Look At EmbedWay Technologies (Shanghai)'s Liabilities

We can see from the most recent balance sheet that EmbedWay Technologies (Shanghai) had liabilities of CN¥946.4m falling due within a year, and liabilities of CN¥26.5m due beyond that. Offsetting these obligations, it had cash of CN¥467.3m as well as receivables valued at CN¥507.2m due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to EmbedWay Technologies (Shanghai)'s size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥7.33b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that EmbedWay Technologies (Shanghai) has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that EmbedWay Technologies (Shanghai) grew its EBIT by 128% over twelve months. That boost will make it even 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 EmbedWay Technologies (Shanghai) 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While EmbedWay Technologies (Shanghai) 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. Considering the last three years, EmbedWay Technologies (Shanghai) actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that EmbedWay Technologies (Shanghai) has net cash of CN¥227.4m, as well as more liquid assets than liabilities. And we liked the look of last year's 128% year-on-year EBIT growth. So we don't have any problem with EmbedWay Technologies (Shanghai)'s use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of EmbedWay Technologies (Shanghai)'s earnings per share history for free.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com