Shenzhen Absen OptoelectronicLtd (SZSE:300389) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that Shenzhen Absen Optoelectronic Co.,Ltd. (SZSE:300389) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shenzhen Absen OptoelectronicLtd

What Is Shenzhen Absen OptoelectronicLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Shenzhen Absen OptoelectronicLtd had debt of CN¥18.5m at the end of September 2023, a reduction from CN¥36.3m over a year. However, it does have CN¥959.3m in cash offsetting this, leading to net cash of CN¥940.8m.

How Healthy Is Shenzhen Absen OptoelectronicLtd's Balance Sheet?

According to the last reported balance sheet, Shenzhen Absen OptoelectronicLtd had liabilities of CN¥2.05b due within 12 months, and liabilities of CN¥68.7m due beyond 12 months. Offsetting this, it had CN¥959.3m in cash and CN¥555.8m in receivables that were due within 12 months. So it has liabilities totalling CN¥605.2m more than its cash and near-term receivables, combined.

Given Shenzhen Absen OptoelectronicLtd has a market capitalization of CN¥6.45b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Shenzhen Absen OptoelectronicLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Shenzhen Absen OptoelectronicLtd grew its EBIT by 107% 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 it is future earnings, more than anything, that will determine Shenzhen Absen OptoelectronicLtd's ability to maintain a healthy balance sheet going forward. 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. Shenzhen Absen OptoelectronicLtd 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. Happily for any shareholders, Shenzhen Absen OptoelectronicLtd actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

We could understand if investors are concerned about Shenzhen Absen OptoelectronicLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥940.8m. The cherry on top was that in converted 228% of that EBIT to free cash flow, bringing in CN¥688m. So we don't think Shenzhen Absen OptoelectronicLtd's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Shenzhen Absen OptoelectronicLtd you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.