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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Shanghai Qingpu Fire-Fighting Equipment Co., Ltd. (HKG:8115) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Shanghai Qingpu Fire-Fighting Equipment's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2021 Shanghai Qingpu Fire-Fighting Equipment had CN¥11.9m of debt, an increase on CN¥2.61m, over one year. But on the other hand it also has CN¥33.2m in cash, leading to a CN¥21.3m net cash position.
How Strong Is Shanghai Qingpu Fire-Fighting Equipment's Balance Sheet?
According to the last reported balance sheet, Shanghai Qingpu Fire-Fighting Equipment had liabilities of CN¥24.1m due within 12 months, and liabilities of CN¥8.04m due beyond 12 months. Offsetting these obligations, it had cash of CN¥33.2m as well as receivables valued at CN¥5.61m due within 12 months. So it actually has CN¥6.67m more liquid assets than total liabilities.
This surplus suggests that Shanghai Qingpu Fire-Fighting Equipment has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shanghai Qingpu Fire-Fighting Equipment boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that Shanghai Qingpu Fire-Fighting Equipment saw its EBIT decline by 8.4% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shanghai Qingpu Fire-Fighting Equipment's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shanghai Qingpu Fire-Fighting Equipment 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. During the last two years, Shanghai Qingpu Fire-Fighting Equipment burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While it is always sensible to investigate a company's debt, in this case Shanghai Qingpu Fire-Fighting Equipment has CN¥21.3m in net cash and a decent-looking balance sheet. So we don't have any problem with Shanghai Qingpu Fire-Fighting Equipment's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Shanghai Qingpu Fire-Fighting Equipment that you should be aware of before investing here.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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.
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