Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, Jiangsu Tongli Risheng Machinery Co., Ltd. (SHSE:605286) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Jiangsu Tongli Risheng Machinery Carry?
The chart below, which you can click on for greater detail, shows that Jiangsu Tongli Risheng Machinery had CN¥462.5m in debt in September 2023; about the same as the year before. But it also has CN¥640.1m in cash to offset that, meaning it has CN¥177.6m net cash.
How Strong Is Jiangsu Tongli Risheng Machinery's Balance Sheet?
We can see from the most recent balance sheet that Jiangsu Tongli Risheng Machinery had liabilities of CN¥1.16b falling due within a year, and liabilities of CN¥199.7m due beyond that. Offsetting these obligations, it had cash of CN¥640.1m as well as receivables valued at CN¥1.20b due within 12 months. So it actually has CN¥485.4m more liquid assets than total liabilities.
This short term liquidity is a sign that Jiangsu Tongli Risheng Machinery could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Jiangsu Tongli Risheng Machinery has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Jiangsu Tongli Risheng Machinery has boosted its EBIT by 40%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Jiangsu Tongli Risheng Machinery will need earnings to service that debt. 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Jiangsu Tongli Risheng 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, Jiangsu Tongli Risheng Machinery saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Summing Up
While it is always sensible to investigate a company's debt, in this case Jiangsu Tongli Risheng Machinery has CN¥177.6m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 40% over the last year. So we don't have any problem with Jiangsu Tongli Risheng Machinery's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Jiangsu Tongli Risheng Machinery .
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.