These 4 Measures Indicate That Zhejiang Dahua Technology (SZSE:002236) Is Using Debt Safely

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 Zhejiang Dahua Technology Co., Ltd. (SZSE:002236) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Zhejiang Dahua Technology

What Is Zhejiang Dahua Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that Zhejiang Dahua Technology had CN¥1.42b of debt in September 2024, down from CN¥2.61b, one year before. However, it does have CN¥9.33b in cash offsetting this, leading to net cash of CN¥7.91b.

How Strong Is Zhejiang Dahua Technology's Balance Sheet?

According to the last reported balance sheet, Zhejiang Dahua Technology had liabilities of CN¥13.4b due within 12 months, and liabilities of CN¥618.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥9.33b as well as receivables valued at CN¥19.2b due within 12 months. So it actually has CN¥14.5b more liquid assets than total liabilities.

This excess liquidity is a great indication that Zhejiang Dahua Technology's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Zhejiang Dahua Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Zhejiang Dahua Technology has increased its EBIT by 3.0% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhejiang Dahua Technology 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Zhejiang Dahua 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. Over the most recent three years, Zhejiang Dahua Technology recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Dahua Technology has CN¥7.91b in net cash and a decent-looking balance sheet. So we don't think Zhejiang Dahua Technology'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. For example Zhejiang Dahua Technology has 2 warning signs (and 1 which is concerning) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.