The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Neway Valve (Suzhou) Co., Ltd. (SHSE:603699) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Neway Valve (Suzhou)'s Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Neway Valve (Suzhou) had CN¥1.12b of debt, an increase on CN¥684.7m, over one year. However, it does have CN¥1.14b in cash offsetting this, leading to net cash of CN¥21.6m.

A Look At Neway Valve (Suzhou)'s Liabilities

According to the last reported balance sheet, Neway Valve (Suzhou) had liabilities of CN¥3.95b due within 12 months, and liabilities of CN¥67.9m due beyond 12 months. On the other hand, it had cash of CN¥1.14b and CN¥2.48b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥392.3m.

Of course, Neway Valve (Suzhou) has a market capitalization of CN¥11.7b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Neway Valve (Suzhou) boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Neway Valve (Suzhou) grew its EBIT by 100% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Neway Valve (Suzhou) can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Neway Valve (Suzhou) 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. During the last three years, Neway Valve (Suzhou) produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Neway Valve (Suzhou) has CN¥21.6m in net cash. And it impressed us with its EBIT growth of 100% over the last year. So is Neway Valve (Suzhou)'s debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with Neway Valve (Suzhou) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.