Is Xi'an NovaStar Tech (SZSE:301589) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Xi'an NovaStar Tech Co., Ltd. (SZSE:301589) makes use of debt. But should shareholders be worried about its use of debt?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Xi'an NovaStar Tech

How Much Debt Does Xi'an NovaStar Tech Carry?

As you can see below, at the end of March 2024, Xi'an NovaStar Tech had CN¥755.4m of debt, up from CN¥459.5m a year ago. Click the image for more detail. However, it does have CN¥1.97b in cash offsetting this, leading to net cash of CN¥1.22b.

How Strong Is Xi'an NovaStar Tech's Balance Sheet?

We can see from the most recent balance sheet that Xi'an NovaStar Tech had liabilities of CN¥1.31b falling due within a year, and liabilities of CN¥527.8m due beyond that. Offsetting this, it had CN¥1.97b in cash and CN¥1.02b in receivables that were due within 12 months. So it can boast CN¥1.16b more liquid assets than total liabilities.

This short term liquidity is a sign that Xi'an NovaStar Tech could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Xi'an NovaStar Tech has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Xi'an NovaStar Tech has boosted its EBIT by 94%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Xi'an NovaStar Tech's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Xi'an NovaStar Tech 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, Xi'an NovaStar Tech saw substantial negative free cash flow, in total. 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

While it is always sensible to investigate a company's debt, in this case Xi'an NovaStar Tech has CN¥1.22b in net cash and a decent-looking balance sheet. And we liked the look of last year's 94% year-on-year EBIT growth. So we are not troubled with Xi'an NovaStar Tech's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Xi'an NovaStar Tech (1 can't be ignored) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.