Here's Why Zhejiang Hechuan Technology (SHSE:688320) Has A Meaningful Debt Burden

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.' 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 Zhejiang Hechuan Technology Co., Ltd. (SHSE:688320) makes use of debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Zhejiang Hechuan Technology

What Is Zhejiang Hechuan Technology's Debt?

As you can see below, at the end of September 2023, Zhejiang Hechuan Technology had CN¥203.5m of debt, up from CN¥60.5m a year ago. Click the image for more detail. However, it does have CN¥268.6m in cash offsetting this, leading to net cash of CN¥65.2m.

How Strong Is Zhejiang Hechuan Technology's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Hechuan Technology had liabilities of CN¥611.0m falling due within a year, and liabilities of CN¥49.8m due beyond that. On the other hand, it had cash of CN¥268.6m and CN¥748.3m worth of receivables due within a year. So it actually has CN¥356.1m more liquid assets than total liabilities.

This surplus suggests that Zhejiang Hechuan Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Zhejiang Hechuan Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Zhejiang Hechuan Technology if management cannot prevent a repeat of the 26% cut to EBIT over the last year. 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 Zhejiang Hechuan Technology's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Zhejiang Hechuan Technology 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, Zhejiang Hechuan Technology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Hechuan Technology has CN¥65.2m in net cash and a decent-looking balance sheet. So while Zhejiang Hechuan Technology does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Zhejiang Hechuan Technology that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.