Is Sunonwealth Electric Machine Industry (TWSE:2421) Using Too Much Debt?

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. As with many other companies Sunonwealth Electric Machine Industry Co., Ltd. (TWSE:2421) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

View our latest analysis for Sunonwealth Electric Machine Industry

What Is Sunonwealth Electric Machine Industry's Debt?

The image below, which you can click on for greater detail, shows that Sunonwealth Electric Machine Industry had debt of NT$1.42b at the end of June 2024, a reduction from NT$2.35b over a year. But it also has NT$5.15b in cash to offset that, meaning it has NT$3.74b net cash.

How Healthy Is Sunonwealth Electric Machine Industry's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sunonwealth Electric Machine Industry had liabilities of NT$6.62b due within 12 months and liabilities of NT$983.1m due beyond that. Offsetting these obligations, it had cash of NT$5.15b as well as receivables valued at NT$3.90b due within 12 months. So it can boast NT$1.45b more liquid assets than total liabilities.

This surplus suggests that Sunonwealth Electric Machine Industry has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Sunonwealth Electric Machine Industry boasts net cash, so it's fair to say it does not have a heavy debt load!

Sunonwealth Electric Machine Industry's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Sunonwealth Electric Machine Industry'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sunonwealth Electric Machine Industry 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. Happily for any shareholders, Sunonwealth Electric Machine Industry actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sunonwealth Electric Machine Industry has NT$3.74b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 112% of that EBIT to free cash flow, bringing in NT$2.2b. So is Sunonwealth Electric Machine Industry's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Sunonwealth Electric Machine Industry you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.