Here's Why Avary Holding(Shenzhen)Co (SZSE:002938) Can Manage Its Debt Responsibly

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?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, 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.

See our latest analysis for Avary Holding(Shenzhen)Co

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

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Avary Holding(Shenzhen)Co had CN¥4.14b of debt, an increase on CN¥3.14b, over one year. But it also has CN¥10.9b in cash to offset that, meaning it has CN¥6.77b net cash.

A Look At Avary Holding(Shenzhen)Co's Liabilities

We can see from the most recent balance sheet that Avary Holding(Shenzhen)Co had liabilities of CN¥11.8b falling due within a year, and liabilities of CN¥763.2m due beyond that. Offsetting this, it had CN¥10.9b in cash and CN¥6.22b in receivables that were due within 12 months. So it actually has CN¥4.53b more liquid assets than total liabilities.

This short term liquidity is a sign that Avary Holding(Shenzhen)Co could probably pay off its debt with ease, as its balance sheet is far from stretched. 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.

It is just as well that Avary Holding(Shenzhen)Co's load is not too heavy, because its EBIT was down 41% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Avary Holding(Shenzhen)Co's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 most recent three years, Avary Holding(Shenzhen)Co recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Avary Holding(Shenzhen)Co has CN¥6.77b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥4.5b, being 69% of its EBIT. So we don't have any problem with Avary Holding(Shenzhen)Co's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Avary Holding(Shenzhen)Co that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.