Skyworth Digital (SZSE:000810) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Skyworth Digital Co., Ltd. (SZSE:000810) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Skyworth Digital

How Much Debt Does Skyworth Digital Carry?

As you can see below, Skyworth Digital had CN¥379.0m of debt at September 2023, down from CN¥1.17b a year prior. But on the other hand it also has CN¥3.16b in cash, leading to a CN¥2.78b net cash position.

How Strong Is Skyworth Digital's Balance Sheet?

We can see from the most recent balance sheet that Skyworth Digital had liabilities of CN¥3.89b falling due within a year, and liabilities of CN¥166.7m due beyond that. On the other hand, it had cash of CN¥3.16b and CN¥3.27b worth of receivables due within a year. So it can boast CN¥2.37b more liquid assets than total liabilities.

This excess liquidity suggests that Skyworth Digital is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Skyworth Digital has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Skyworth Digital's load is not too heavy, because its EBIT was down 47% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Skyworth Digital's ability to maintain a healthy balance sheet going forward. 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 Skyworth Digital 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. 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¥2.78b, as well as more liquid assets than liabilities. The cherry on top was that in converted 156% of that EBIT to free cash flow, bringing in CN¥141m. So we don't think Skyworth Digital's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Skyworth Digital .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.