Zhuzhou Hongda ElectronicsLtd (SZSE:300726) Has A Pretty Healthy Balance Sheet

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.' 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. As with many other companies Zhuzhou Hongda Electronics Corp.,Ltd. (SZSE:300726) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Zhuzhou Hongda ElectronicsLtd

What Is Zhuzhou Hongda ElectronicsLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Zhuzhou Hongda ElectronicsLtd had CN¥15.0m of debt, an increase on CN¥5.00m, over one year. But on the other hand it also has CN¥888.0m in cash, leading to a CN¥873.0m net cash position.

How Healthy Is Zhuzhou Hongda ElectronicsLtd's Balance Sheet?

We can see from the most recent balance sheet that Zhuzhou Hongda ElectronicsLtd had liabilities of CN¥502.9m falling due within a year, and liabilities of CN¥225.8m due beyond that. Offsetting this, it had CN¥888.0m in cash and CN¥2.25b in receivables that were due within 12 months. So it can boast CN¥2.40b more liquid assets than total liabilities.

It's good to see that Zhuzhou Hongda ElectronicsLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Zhuzhou Hongda ElectronicsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Zhuzhou Hongda ElectronicsLtd if management cannot prevent a repeat of the 31% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Zhuzhou Hongda ElectronicsLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Zhuzhou Hongda ElectronicsLtd 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. Over the last three years, Zhuzhou Hongda ElectronicsLtd reported free cash flow worth 16% 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 we empathize with investors who find debt concerning, you should keep in mind that Zhuzhou Hongda ElectronicsLtd has net cash of CN¥873.0m, as well as more liquid assets than liabilities. So we are not troubled with Zhuzhou Hongda ElectronicsLtd's debt use. 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 1 warning sign with Zhuzhou Hongda ElectronicsLtd , 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.