Sunray Engineering Group (HKG:8616) Has A Pretty Healthy Balance Sheet

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. We note that Sunray Engineering Group Limited (HKG:8616) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Sunray Engineering Group

What Is Sunray Engineering Group's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Sunray Engineering Group had debt of HK$24.6m, up from none in one year. However, it does have HK$35.9m in cash offsetting this, leading to net cash of HK$11.3m.

A Look At Sunray Engineering Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Sunray Engineering Group had liabilities of HK$64.2m due within 12 months and liabilities of HK$2.18m due beyond that. Offsetting this, it had HK$35.9m in cash and HK$128.3m in receivables that were due within 12 months. So it actually has HK$97.8m more liquid assets than total liabilities.

This excess liquidity is a great indication that Sunray Engineering Group's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Sunray Engineering Group has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Sunray Engineering Group saw its EBIT decline by 6.2% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is Sunray Engineering Group'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sunray Engineering Group 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 three years, Sunray Engineering Group 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

While it is always sensible to investigate a company's debt, in this case Sunray Engineering Group has HK$11.3m in net cash and a decent-looking balance sheet. So we are not troubled with Sunray Engineering Group'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. For example, we've discovered 3 warning signs for Sunray Engineering Group (1 can't be ignored!) that you should be aware of before investing here.

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.