We Think Zhongji Innolight (SZSE:300308) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Zhongji Innolight Co., Ltd. (SZSE:300308) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Zhongji Innolight

What Is Zhongji Innolight's Net Debt?

The chart below, which you can click on for greater detail, shows that Zhongji Innolight had CN¥1.32b in debt in June 2024; about the same as the year before. However, it does have CN¥3.59b in cash offsetting this, leading to net cash of CN¥2.26b.

A Look At Zhongji Innolight's Liabilities

The latest balance sheet data shows that Zhongji Innolight had liabilities of CN¥5.39b due within a year, and liabilities of CN¥1.89b falling due after that. Offsetting this, it had CN¥3.59b in cash and CN¥4.36b in receivables that were due within 12 months. So it can boast CN¥665.1m more liquid assets than total liabilities.

Having regard to Zhongji Innolight's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥119.3b 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.

Even more impressive was the fact that Zhongji Innolight grew its EBIT by 195% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Zhongji Innolight'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. Looking at the most recent three years, Zhongji Innolight recorded free cash flow of 30% 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 Zhongji Innolight has CN¥2.26b in net cash and a decent-looking balance sheet. And we liked the look of last year's 195% 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. We've identified 2 warning signs with Zhongji Innolight (at least 1 which is a bit unpleasant) , 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.