Avary Holding(Shenzhen)Co (SZSE:002938) Has A Pretty Healthy Balance Sheet

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. We can see that Avary Holding(Shenzhen)Co., Limited (SZSE:002938) does use debt in its business. But is this debt a concern to shareholders?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Avary Holding(Shenzhen)Co

What Is Avary Holding(Shenzhen)Co's Net Debt?

The image below, which you can click on for greater detail, shows that Avary Holding(Shenzhen)Co had debt of CN¥3.47b at the end of March 2024, a reduction from CN¥3.92b over a year. But on the other hand it also has CN¥11.8b in cash, leading to a CN¥8.32b net cash position.

How Healthy Is Avary Holding(Shenzhen)Co's Balance Sheet?

The latest balance sheet data shows that Avary Holding(Shenzhen)Co had liabilities of CN¥9.24b due within a year, and liabilities of CN¥783.6m falling due after that. Offsetting these obligations, it had cash of CN¥11.8b as well as receivables valued at CN¥3.93b due within 12 months. So it actually has CN¥5.69b more liquid assets than total liabilities.

This surplus suggests that Avary Holding(Shenzhen)Co has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Avary Holding(Shenzhen)Co has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Avary Holding(Shenzhen)Co if management cannot prevent a repeat of the 44% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Avary Holding(Shenzhen)Co 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. While Avary Holding(Shenzhen)Co 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, Avary Holding(Shenzhen)Co recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Avary Holding(Shenzhen)Co has CN¥8.32b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in CN¥4.1b. So we are not troubled with Avary Holding(Shenzhen)Co's debt use. 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. Be aware that Avary Holding(Shenzhen)Co is showing 1 warning sign in our investment analysis , 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.

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