We Think Nanjing Xinlian Electronics (SZSE:002546) Can Manage Its Debt With Ease

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Nanjing Xinlian Electronics Co., Ltd (SZSE:002546) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Nanjing Xinlian Electronics

What Is Nanjing Xinlian Electronics's Net Debt?

As you can see below, at the end of September 2024, Nanjing Xinlian Electronics had CN¥24.0m of debt, up from CN¥20.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥2.57b in cash, so it actually has CN¥2.54b net cash.

A Look At Nanjing Xinlian Electronics' Liabilities

Zooming in on the latest balance sheet data, we can see that Nanjing Xinlian Electronics had liabilities of CN¥364.1m due within 12 months and liabilities of CN¥15.2m due beyond that. Offsetting these obligations, it had cash of CN¥2.57b as well as receivables valued at CN¥313.2m due within 12 months. So it can boast CN¥2.50b more liquid assets than total liabilities.

This luscious liquidity implies that Nanjing Xinlian Electronics' balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Nanjing Xinlian Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

We saw Nanjing Xinlian Electronics grow its EBIT by 7.2% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Nanjing Xinlian Electronics will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Nanjing Xinlian Electronics 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, Nanjing Xinlian Electronics recorded free cash flow worth a fulsome 93% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Nanjing Xinlian Electronics has net cash of CN¥2.54b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥281m, being 93% of its EBIT. So we don't think Nanjing Xinlian Electronics'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. For example, we've discovered 4 warning signs for Nanjing Xinlian Electronics (1 is a bit unpleasant!) that you should be aware of before investing here.

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.