Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Sunward Intelligent Equipment Co., Ltd. (SZSE:002097) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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 Sunward Intelligent Equipment Carry?

As you can see below, at the end of September 2023, Sunward Intelligent Equipment had CN¥10.5b of debt, up from CN¥9.07b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥1.70b, its net debt is less, at about CN¥8.83b.

How Strong Is Sunward Intelligent Equipment's Balance Sheet?

We can see from the most recent balance sheet that Sunward Intelligent Equipment had liabilities of CN¥8.19b falling due within a year, and liabilities of CN¥8.16b due beyond that. Offsetting this, it had CN¥1.70b in cash and CN¥7.40b in receivables that were due within 12 months. So it has liabilities totalling CN¥7.26b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥6.49b, we think shareholders really should watch Sunward Intelligent Equipment's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sunward Intelligent Equipment 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.

Over 12 months, Sunward Intelligent Equipment made a loss at the EBIT level, and saw its revenue drop to CN¥7.2b, which is a fall of 7.3%. We would much prefer see growth.

Caveat Emptor

Importantly, Sunward Intelligent Equipment had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥417m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of CN¥1.3b over the last twelve months. That means it's on the risky side of things. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Sunward Intelligent Equipment you should know about.

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.