Is Zhongji Innolight (SZSE:300308) A Risky Investment?

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. Importantly, Zhongji Innolight Co., Ltd. (SZSE:300308) does carry debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

Check out our latest analysis for Zhongji Innolight

What Is Zhongji Innolight's Debt?

As you can see below, at the end of September 2024, Zhongji Innolight had CN¥1.98b of debt, up from CN¥1.31b a year ago. Click the image for more detail. However, it does have CN¥3.75b in cash offsetting this, leading to net cash of CN¥1.77b.

How Strong Is Zhongji Innolight's Balance Sheet?

According to the last reported balance sheet, Zhongji Innolight had liabilities of CN¥6.94b due within 12 months, and liabilities of CN¥1.50b due beyond 12 months. On the other hand, it had cash of CN¥3.75b and CN¥5.08b worth of receivables due within a year. So it actually has CN¥392.9m more liquid assets than total liabilities.

This state of affairs indicates that Zhongji Innolight's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥119.1b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Zhongji Innolight has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Zhongji Innolight grew its EBIT by 186% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhongji Innolight 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. Zhongji Innolight may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Zhongji Innolight reported free cash flow worth 18% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhongji Innolight has CN¥1.77b in net cash and a decent-looking balance sheet. And we liked the look of last year's 186% year-on-year EBIT growth. So we don't think Zhongji Innolight's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Zhongji Innolight you should be aware of, and 1 of them can't be ignored.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.