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, SBT Ultrasonic Technology Co.,Ltd. (SHSE:688392) does carry debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
What Is SBT Ultrasonic TechnologyLtd's Debt?
As you can see below, at the end of September 2023, SBT Ultrasonic TechnologyLtd had CN¥225.5m of debt, up from CN¥135.1m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.52b in cash, so it actually has CN¥1.29b net cash.
How Strong Is SBT Ultrasonic TechnologyLtd's Balance Sheet?
We can see from the most recent balance sheet that SBT Ultrasonic TechnologyLtd had liabilities of CN¥370.9m falling due within a year, and liabilities of CN¥18.3m due beyond that. Offsetting this, it had CN¥1.52b in cash and CN¥280.3m in receivables that were due within 12 months. So it actually has CN¥1.41b more liquid assets than total liabilities.
This excess liquidity suggests that SBT Ultrasonic TechnologyLtd is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that SBT Ultrasonic TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact SBT Ultrasonic TechnologyLtd's saving grace is its low debt levels, because its EBIT has tanked 29% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 SBT Ultrasonic TechnologyLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While SBT Ultrasonic TechnologyLtd 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, SBT Ultrasonic TechnologyLtd recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
Summing Up
While it is always sensible to investigate a company's debt, in this case SBT Ultrasonic TechnologyLtd has CN¥1.29b in net cash and a decent-looking balance sheet. So we don't have any problem with SBT Ultrasonic TechnologyLtd'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. Be aware that SBT Ultrasonic TechnologyLtd is showing 2 warning signs in our investment analysis , you should know about...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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.