Is Avary Holding(Shenzhen)Co (SZSE:002938) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 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 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.

View our latest analysis for Avary Holding(Shenzhen)Co

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

The chart below, which you can click on for greater detail, shows that Avary Holding(Shenzhen)Co had CN¥3.68b in debt in September 2024; about the same as the year before. But it also has CN¥10.2b in cash to offset that, meaning it has CN¥6.55b net cash.

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

We can see from the most recent balance sheet that Avary Holding(Shenzhen)Co had liabilities of CN¥12.5b falling due within a year, and liabilities of CN¥986.1m due beyond that. On the other hand, it had cash of CN¥10.2b and CN¥7.04b worth of receivables due within a year. So it can boast CN¥3.84b 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.

But the bad news is that Avary Holding(Shenzhen)Co has seen its EBIT plunge 12% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. 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'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 actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Avary Holding(Shenzhen)Co has CN¥6.55b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in CN¥2.9b. So we don't think Avary Holding(Shenzhen)Co's use of debt is risky. 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. We've identified 1 warning sign with Avary Holding(Shenzhen)Co , and understanding them should be part of your investment process.

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.