Here's Why DongHua Testing Technology (SZSE:300354) Can Manage Its Debt Responsibly

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. We can see that DongHua Testing Technology Co. , Ltd. (SZSE:300354) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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.

See our latest analysis for DongHua Testing Technology

What Is DongHua Testing Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 DongHua Testing Technology had debt of CN¥18.0m, up from none in one year. However, its balance sheet shows it holds CN¥30.6m in cash, so it actually has CN¥12.6m net cash.

A Look At DongHua Testing Technology's Liabilities

According to the last reported balance sheet, DongHua Testing Technology had liabilities of CN¥81.8m due within 12 months, and liabilities of CN¥6.48m due beyond 12 months. Offsetting these obligations, it had cash of CN¥30.6m as well as receivables valued at CN¥422.5m due within 12 months. So it actually has CN¥364.8m more liquid assets than total liabilities.

This surplus suggests that DongHua Testing Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that DongHua Testing Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact DongHua Testing Technology's saving grace is its low debt levels, because its EBIT has tanked 27% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 DongHua Testing 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 DongHua Testing 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. Considering the last three years, DongHua Testing Technology actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case DongHua Testing Technology has CN¥12.6m in net cash and a decent-looking balance sheet. So we don't have any problem with DongHua Testing Technology's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in DongHua Testing Technology, you may well want to click here to check an interactive graph of its earnings per share history.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.