Shenzhen hongfuhan Technology (SZSE:301086) Takes On Some Risk With Its Use Of 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.' 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. Importantly, Shenzhen hongfuhan Technology Co. Ltd. (SZSE:301086) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shenzhen hongfuhan Technology

How Much Debt Does Shenzhen hongfuhan Technology Carry?

As you can see below, at the end of September 2024, Shenzhen hongfuhan Technology had CN¥331.2m of debt, up from CN¥224.4m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥788.4m in cash, so it actually has CN¥457.2m net cash.

A Look At Shenzhen hongfuhan Technology's Liabilities

According to the last reported balance sheet, Shenzhen hongfuhan Technology had liabilities of CN¥505.1m due within 12 months, and liabilities of CN¥135.1m due beyond 12 months. Offsetting this, it had CN¥788.4m in cash and CN¥429.8m in receivables that were due within 12 months. So it actually has CN¥578.0m more liquid assets than total liabilities.

This surplus suggests that Shenzhen hongfuhan Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shenzhen hongfuhan Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Shenzhen hongfuhan Technology's load is not too heavy, because its EBIT was down 22% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shenzhen hongfuhan Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Shenzhen hongfuhan 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. Over the last three years, Shenzhen hongfuhan Technology saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen hongfuhan Technology has net cash of CN¥457.2m, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Shenzhen hongfuhan Technology's balance sheet. 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. For instance, we've identified 4 warning signs for Shenzhen hongfuhan Technology (2 are a bit concerning) you should be aware of.

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.