Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Wuxi Huadong Heavy Machinery Co., Ltd. (SZSE:002685) does use debt in its business. But should shareholders be worried about its use of debt?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for Wuxi Huadong Heavy Machinery

What Is Wuxi Huadong Heavy Machinery's Net Debt?

As you can see below, Wuxi Huadong Heavy Machinery had CN¥258.6m of debt, at June 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥481.4m in cash offsetting this, leading to net cash of CN¥222.8m.

How Healthy Is Wuxi Huadong Heavy Machinery's Balance Sheet?

According to the last reported balance sheet, Wuxi Huadong Heavy Machinery had liabilities of CN¥980.2m due within 12 months, and liabilities of CN¥148.6m due beyond 12 months. Offsetting this, it had CN¥481.4m in cash and CN¥964.9m in receivables that were due within 12 months. So it actually has CN¥317.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Wuxi Huadong Heavy Machinery could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Wuxi Huadong Heavy Machinery boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Wuxi Huadong Heavy 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.

In the last year Wuxi Huadong Heavy Machinery had a loss before interest and tax, and actually shrunk its revenue by 64%, to CN¥1.3b. That makes us nervous, to say the least.

So How Risky Is Wuxi Huadong Heavy Machinery?

Although Wuxi Huadong Heavy Machinery had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥56m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. 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. To that end, you should learn about the 2 warning signs we've spotted with Wuxi Huadong Heavy Machinery (including 1 which is concerning) .

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.