These 4 Measures Indicate That Shenzhen Microgate Technology (SZSE:300319) Is Using Debt Safely

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Shenzhen Microgate Technology Co., Ltd. (SZSE:300319) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 Shenzhen Microgate Technology

What Is Shenzhen Microgate Technology's Debt?

As you can see below, at the end of September 2024, Shenzhen Microgate Technology had CN¥289.8m of debt, up from CN¥47.3m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥797.4m in cash, so it actually has CN¥507.6m net cash.

How Healthy Is Shenzhen Microgate Technology's Balance Sheet?

According to the last reported balance sheet, Shenzhen Microgate Technology had liabilities of CN¥1.83b due within 12 months, and liabilities of CN¥250.8m due beyond 12 months. Offsetting this, it had CN¥797.4m in cash and CN¥1.37b in receivables that were due within 12 months. So it can boast CN¥89.2m more liquid assets than total liabilities.

Having regard to Shenzhen Microgate Technology's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥11.4b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Shenzhen Microgate Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Shenzhen Microgate Technology has boosted its EBIT by 52%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shenzhen Microgate Technology can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shenzhen Microgate 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. During the last three years, Shenzhen Microgate Technology generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen Microgate Technology has CN¥507.6m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in CN¥74m. So we don't think Shenzhen Microgate Technology's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Shenzhen Microgate Technology , 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.

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.