We Think HONG RI DA Technology (SZSE:301285) Is Taking Some Risk With Its Debt

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. We can see that HONG RI DA Technology Company Limited (SZSE:301285) 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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for HONG RI DA Technology

What Is HONG RI DA Technology's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 HONG RI DA Technology had debt of CN¥520.4m, up from CN¥392.0m in one year. However, its balance sheet shows it holds CN¥542.5m in cash, so it actually has CN¥22.1m net cash.

How Healthy Is HONG RI DA Technology's Balance Sheet?

We can see from the most recent balance sheet that HONG RI DA Technology had liabilities of CN¥868.2m falling due within a year, and liabilities of CN¥60.0m due beyond that. On the other hand, it had cash of CN¥542.5m and CN¥335.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥50.4m.

This state of affairs indicates that HONG RI DA Technology's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥5.85b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, HONG RI DA Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact HONG RI DA Technology's saving grace is its low debt levels, because its EBIT has tanked 29% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is HONG RI DA 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While HONG RI DA 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, HONG RI DA Technology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

We could understand if investors are concerned about HONG RI DA Technology's liabilities, but we can be reassured by the fact it has has net cash of CN¥22.1m. So while HONG RI DA Technology does not have a great balance sheet, it's certainly not too bad. 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. To that end, you should be aware of the 2 warning signs we've spotted with HONG RI DA Technology .

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.