Here's Why Beijing Zhong Ke San Huan High-Tech (SZSE:000970) 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.' 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. We note that Beijing Zhong Ke San Huan High-Tech Co., Ltd. (SZSE:000970) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Beijing Zhong Ke San Huan High-Tech

How Much Debt Does Beijing Zhong Ke San Huan High-Tech Carry?

The image below, which you can click on for greater detail, shows that Beijing Zhong Ke San Huan High-Tech had debt of CN¥1.57b at the end of March 2024, a reduction from CN¥1.98b over a year. But it also has CN¥2.45b in cash to offset that, meaning it has CN¥882.3m net cash.

How Healthy Is Beijing Zhong Ke San Huan High-Tech's Balance Sheet?

The latest balance sheet data shows that Beijing Zhong Ke San Huan High-Tech had liabilities of CN¥2.20b due within a year, and liabilities of CN¥853.5m falling due after that. Offsetting this, it had CN¥2.45b in cash and CN¥2.45b in receivables that were due within 12 months. So it can boast CN¥1.84b more liquid assets than total liabilities.

This surplus suggests that Beijing Zhong Ke San Huan High-Tech is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Beijing Zhong Ke San Huan High-Tech boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Beijing Zhong Ke San Huan High-Tech if management cannot prevent a repeat of the 88% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Beijing Zhong Ke San Huan High-Tech can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Beijing Zhong Ke San Huan High-Tech 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. Over the last three years, Beijing Zhong Ke San Huan High-Tech saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Beijing Zhong Ke San Huan High-Tech has net cash of CN¥882.3m, as well as more liquid assets than liabilities. So we don't have any problem with Beijing Zhong Ke San Huan High-Tech's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Beijing Zhong Ke San Huan High-Tech has 2 warning signs we think 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.

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