These 4 Measures Indicate That Hwa Fong Rubber Industrial (TWSE:2109) Is Using Debt Reasonably Well

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Hwa Fong Rubber Industrial Co., Ltd. (TWSE:2109) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, 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.

Check out our latest analysis for Hwa Fong Rubber Industrial

What Is Hwa Fong Rubber Industrial's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Hwa Fong Rubber Industrial had NT$1.55b of debt in September 2023, down from NT$2.30b, one year before. But it also has NT$2.61b in cash to offset that, meaning it has NT$1.05b net cash.

How Strong Is Hwa Fong Rubber Industrial's Balance Sheet?

We can see from the most recent balance sheet that Hwa Fong Rubber Industrial had liabilities of NT$2.77b falling due within a year, and liabilities of NT$333.2m due beyond that. On the other hand, it had cash of NT$2.61b and NT$669.8m worth of receivables due within a year. So it can boast NT$174.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Hwa Fong Rubber Industrial could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Hwa Fong Rubber Industrial boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Hwa Fong Rubber Industrial's saving grace is its low debt levels, because its EBIT has tanked 42% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hwa Fong Rubber Industrial'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Hwa Fong Rubber Industrial 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, Hwa Fong Rubber Industrial 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 we empathize with investors who find debt concerning, you should keep in mind that Hwa Fong Rubber Industrial has net cash of NT$1.05b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$858m, being 100% of its EBIT. So we are not troubled with Hwa Fong Rubber Industrial'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. We've identified 2 warning signs with Hwa Fong Rubber Industrial , and understanding them should be part of your investment process.

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.

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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.