Is Skyworth Digital (SZSE:000810) 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Skyworth Digital Co., Ltd. (SZSE:000810) does carry debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 Skyworth Digital

What Is Skyworth Digital's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Skyworth Digital had debt of CN¥939.9m, up from CN¥344.9m in one year. However, its balance sheet shows it holds CN¥3.64b in cash, so it actually has CN¥2.70b net cash.

How Healthy Is Skyworth Digital's Balance Sheet?

The latest balance sheet data shows that Skyworth Digital had liabilities of CN¥4.16b due within a year, and liabilities of CN¥234.1m falling due after that. On the other hand, it had cash of CN¥3.64b and CN¥3.10b worth of receivables due within a year. So it can boast CN¥2.36b more liquid assets than total liabilities.

It's good to see that Skyworth Digital has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Skyworth Digital boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Skyworth Digital's load is not too heavy, because its EBIT was down 32% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Skyworth Digital 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. Skyworth Digital 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. Happily for any shareholders, Skyworth Digital actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Skyworth Digital has net cash of CN¥2.70b, as well as more liquid assets than liabilities. The cherry on top was that in converted 129% of that EBIT to free cash flow, bringing in CN¥8.7m. So we don't think Skyworth Digital's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Skyworth Digital you should be aware of, and 1 of them is significant.

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.

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

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.