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.' 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 note that Shaanxi Huaqin Technology Industry Co.,Ltd. (SHSE:688281) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Shaanxi Huaqin Technology IndustryLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Shaanxi Huaqin Technology IndustryLtd had debt of CN¥107.7m, up from CN¥219.6k in one year. However, its balance sheet shows it holds CN¥2.70b in cash, so it actually has CN¥2.60b net cash.

How Strong Is Shaanxi Huaqin Technology IndustryLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shaanxi Huaqin Technology IndustryLtd had liabilities of CN¥382.5m due within 12 months and liabilities of CN¥163.7m due beyond that. Offsetting these obligations, it had cash of CN¥2.70b as well as receivables valued at CN¥922.6m due within 12 months. So it actually has CN¥3.08b more liquid assets than total liabilities.

This excess liquidity suggests that Shaanxi Huaqin Technology IndustryLtd is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Shaanxi Huaqin Technology IndustryLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Shaanxi Huaqin Technology IndustryLtd has boosted its EBIT by 36%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shaanxi Huaqin Technology IndustryLtd'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 Shaanxi Huaqin Technology IndustryLtd 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. During the last three years, Shaanxi Huaqin Technology IndustryLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shaanxi Huaqin Technology IndustryLtd has net cash of CN¥2.60b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 36% over the last year. So is Shaanxi Huaqin Technology IndustryLtd's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with Shaanxi Huaqin Technology IndustryLtd .

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.