Dongguan Aohai Technology (SZSE:002993) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Dongguan Aohai Technology Co., Ltd. (SZSE:002993) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Dongguan Aohai Technology

How Much Debt Does Dongguan Aohai Technology Carry?

As you can see below, at the end of June 2024, Dongguan Aohai Technology had CN¥266.4m of debt, up from CN¥185.8m a year ago. Click the image for more detail. However, it does have CN¥3.39b in cash offsetting this, leading to net cash of CN¥3.13b.

How Healthy Is Dongguan Aohai Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dongguan Aohai Technology had liabilities of CN¥3.30b due within 12 months and liabilities of CN¥293.4m due beyond that. On the other hand, it had cash of CN¥3.39b and CN¥1.98b worth of receivables due within a year. So it can boast CN¥1.78b more liquid assets than total liabilities.

This surplus suggests that Dongguan Aohai Technology is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Dongguan Aohai Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Dongguan Aohai Technology grew its EBIT at 14% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Dongguan Aohai Technology can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Dongguan Aohai 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. Looking at the most recent three years, Dongguan Aohai Technology recorded free cash flow of 22% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Dongguan Aohai Technology has CN¥3.13b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 14% over the last year. So is Dongguan Aohai Technology's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 2 warning signs for Dongguan Aohai Technology (1 is concerning) 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.