China Railway Signal & Communication (HKG:3969) Has A Rock Solid 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.' 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. As with many other companies China Railway Signal & Communication Corporation Limited (HKG:3969) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for China Railway Signal & Communication

What Is China Railway Signal & Communication's Net Debt?

You can click the graphic below for the historical numbers, but it shows that China Railway Signal & Communication had CN¥3.38b of debt in March 2024, down from CN¥5.80b, one year before. However, it does have CN¥22.4b in cash offsetting this, leading to net cash of CN¥19.0b.

A Look At China Railway Signal & Communication's Liabilities

Zooming in on the latest balance sheet data, we can see that China Railway Signal & Communication had liabilities of CN¥64.6b due within 12 months and liabilities of CN¥3.89b due beyond that. Offsetting these obligations, it had cash of CN¥22.4b as well as receivables valued at CN¥63.5b due within 12 months. So it actually has CN¥17.4b more liquid assets than total liabilities.

This excess liquidity is a great indication that China Railway Signal & Communication's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that China Railway Signal & Communication 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 China Railway Signal & Communication saw its EBIT decline by 4.4% 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 future earnings, more than anything, that will determine China Railway Signal & Communication'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 company can only pay off debt with cold hard cash, not accounting profits. China Railway Signal & Communication 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. Over the most recent three years, China Railway Signal & Communication recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Railway Signal & Communication has CN¥19.0b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥4.8b, being 69% of its EBIT. So is China Railway Signal & Communication's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for China Railway Signal & Communication 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.