These 4 Measures Indicate That World Precision Machinery (SGX:B49) Is Using Debt Reasonably Well

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, World Precision Machinery Limited (SGX:B49) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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.

View our latest analysis for World Precision Machinery

What Is World Precision Machinery's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 World Precision Machinery had debt of CN¥245.0m, up from none in one year. However, its balance sheet shows it holds CN¥385.8m in cash, so it actually has CN¥140.8m net cash.

How Healthy Is World Precision Machinery's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that World Precision Machinery had liabilities of CN¥933.4m due within 12 months and liabilities of CN¥135.2m due beyond that. Offsetting this, it had CN¥385.8m in cash and CN¥402.5m in receivables that were due within 12 months. So its liabilities total CN¥280.2m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because World Precision Machinery is worth CN¥845.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, World Precision Machinery boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that World Precision Machinery's load is not too heavy, because its EBIT was down 97% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is World Precision Machinery'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. World Precision Machinery 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 last three years, World Precision Machinery actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While World Precision Machinery does have more liabilities than liquid assets, it also has net cash of CN¥140.8m. The cherry on top was that in converted 183% of that EBIT to free cash flow, bringing in -CN¥742k. So we are not troubled with World Precision Machinery's debt use. 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 - World Precision Machinery has 1 warning sign we think you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.