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. We can see that Forehope Electronic (Ningbo) Co., Ltd. (SHSE:688362) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Forehope Electronic (Ningbo) Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2024 Forehope Electronic (Ningbo) had CN¥5.14b of debt, an increase on CN¥2.98b, over one year. However, it does have CN¥2.05b in cash offsetting this, leading to net debt of about CN¥3.09b.
How Healthy Is Forehope Electronic (Ningbo)'s Balance Sheet?
According to the last reported balance sheet, Forehope Electronic (Ningbo) had liabilities of CN¥3.00b due within 12 months, and liabilities of CN¥6.21b due beyond 12 months. Offsetting this, it had CN¥2.05b in cash and CN¥684.6m in receivables that were due within 12 months. So it has liabilities totalling CN¥6.47b more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of CN¥7.42b, so it does suggest shareholders should keep an eye on Forehope Electronic (Ningbo)'s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Forehope Electronic (Ningbo)'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.
In the last year Forehope Electronic (Ningbo) wasn't profitable at an EBIT level, but managed to grow its revenue by 33%, to CN¥2.7b. Shareholders probably have their fingers crossed that it can grow its way to profits.
Caveat Emptor
Despite the top line growth, Forehope Electronic (Ningbo) still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥59m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥2.2b of cash over the last year. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Forehope Electronic (Ningbo) , 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.