MeiG Smart Technology (SZSE:002881) Takes On Some Risk With Its Use Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies MeiG Smart Technology Co., Ltd (SZSE:002881) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for MeiG Smart Technology

What Is MeiG Smart Technology's Debt?

As you can see below, MeiG Smart Technology had CN¥378.5m of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥507.9m in cash offsetting this, leading to net cash of CN¥129.3m.

How Strong Is MeiG Smart Technology's Balance Sheet?

The latest balance sheet data shows that MeiG Smart Technology had liabilities of CN¥1.10b due within a year, and liabilities of CN¥37.2m falling due after that. Offsetting these obligations, it had cash of CN¥507.9m as well as receivables valued at CN¥664.3m due within 12 months. So it actually has CN¥38.0m more liquid assets than total liabilities.

Having regard to MeiG Smart Technology's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥5.76b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that MeiG Smart Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact MeiG Smart Technology's saving grace is its low debt levels, because its EBIT has tanked 68% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine MeiG Smart Technology's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While MeiG Smart Technology 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. Over the last three years, MeiG Smart Technology saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case MeiG Smart Technology has CN¥129.3m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about MeiG Smart Technology's balance sheet. 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. Be aware that MeiG Smart Technology is showing 2 warning signs in our investment analysis , you should know about...

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.