Zhejiang Shengyang Science and TechnologyLtd (SHSE:603703) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Zhejiang Shengyang Science and Technology Co.,Ltd. (SHSE:603703) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Zhejiang Shengyang Science and TechnologyLtd

What Is Zhejiang Shengyang Science and TechnologyLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Zhejiang Shengyang Science and TechnologyLtd had debt of CN¥716.2m at the end of September 2023, a reduction from CN¥841.1m over a year. However, it does have CN¥440.8m in cash offsetting this, leading to net debt of about CN¥275.4m.

How Strong Is Zhejiang Shengyang Science and TechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Shengyang Science and TechnologyLtd had liabilities of CN¥782.9m falling due within a year, and liabilities of CN¥212.5m due beyond that. Offsetting these obligations, it had cash of CN¥440.8m as well as receivables valued at CN¥223.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥331.4m.

Given Zhejiang Shengyang Science and TechnologyLtd has a market capitalization of CN¥4.55b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Zhejiang Shengyang Science and TechnologyLtd's debt to EBITDA ratio (4.6) suggests that it uses some debt, its interest cover is very weak, at 0.70, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. However, the silver lining was that Zhejiang Shengyang Science and TechnologyLtd achieved a positive EBIT of CN¥11m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But it is Zhejiang Shengyang Science and 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Zhejiang Shengyang Science and TechnologyLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Based on what we've seen Zhejiang Shengyang Science and TechnologyLtd is not finding it easy, given its interest cover, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its conversion of EBIT to free cash flow. When we consider all the elements mentioned above, it seems to us that Zhejiang Shengyang Science and TechnologyLtd is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. To that end, you should be aware of the 2 warning signs we've spotted with Zhejiang Shengyang Science and TechnologyLtd .

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.