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 can see that China National Electric Apparatus Research Institute Co., Ltd. (SHSE:688128) does use debt in its business. 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for China National Electric Apparatus Research Institute
How Much Debt Does China National Electric Apparatus Research Institute Carry?
As you can see below, China National Electric Apparatus Research Institute had CN¥15.0m of debt at September 2023, down from CN¥54.9m a year prior. But it also has CN¥668.4m in cash to offset that, meaning it has CN¥653.4m net cash.
How Healthy Is China National Electric Apparatus Research Institute's Balance Sheet?
According to the last reported balance sheet, China National Electric Apparatus Research Institute had liabilities of CN¥4.13b due within 12 months, and liabilities of CN¥231.2m due beyond 12 months. Offsetting these obligations, it had cash of CN¥668.4m as well as receivables valued at CN¥1.90b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.80b.
This deficit isn't so bad because China National Electric Apparatus Research Institute is worth CN¥8.10b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, China National Electric Apparatus Research Institute also has more cash than debt, so we're pretty confident it can manage its debt safely.
In addition to that, we're happy to report that China National Electric Apparatus Research Institute has boosted its EBIT by 37%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China National Electric Apparatus Research Institute'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 National Electric Apparatus Research Institute 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, China National Electric Apparatus Research Institute produced sturdy free cash flow equating to 54% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
Although China National Electric Apparatus Research Institute's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥653.4m. And we liked the look of last year's 37% year-on-year EBIT growth. So is China National Electric Apparatus Research Institute'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. For example - China National Electric Apparatus Research Institute has 1 warning sign we think 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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