These 4 Measures Indicate That Sanchuan Wisdom Technology (SZSE:300066) Is Using Debt Reasonably Well

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Sanchuan Wisdom Technology Co., Ltd. (SZSE:300066) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Sanchuan Wisdom Technology

What Is Sanchuan Wisdom Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that Sanchuan Wisdom Technology had CN¥200.0m of debt in September 2024, down from CN¥317.9m, one year before. However, it does have CN¥522.8m in cash offsetting this, leading to net cash of CN¥322.8m.

A Look At Sanchuan Wisdom Technology's Liabilities

We can see from the most recent balance sheet that Sanchuan Wisdom Technology had liabilities of CN¥439.4m falling due within a year, and liabilities of CN¥32.4m due beyond that. On the other hand, it had cash of CN¥522.8m and CN¥757.9m worth of receivables due within a year. So it can boast CN¥809.0m more liquid assets than total liabilities.

This surplus suggests that Sanchuan Wisdom Technology is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Sanchuan Wisdom Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Sanchuan Wisdom Technology's load is not too heavy, because its EBIT was down 24% over the last year. 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 you can't view debt in total isolation; since Sanchuan Wisdom Technology will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Sanchuan Wisdom 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, Sanchuan Wisdom Technology recorded free cash flow of 26% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sanchuan Wisdom Technology has net cash of CN¥322.8m, as well as more liquid assets than liabilities. So we don't have any problem with Sanchuan Wisdom Technology's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Sanchuan Wisdom Technology 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.