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 can see that Jiangsu Asia-Pacific Light Alloy Technology Co., Ltd. (SZSE:002540) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Jiangsu Asia-Pacific Light Alloy Technology's Net Debt?

As you can see below, at the end of September 2023, Jiangsu Asia-Pacific Light Alloy Technology had CN¥1.01b of debt, up from CN¥116.5m a year ago. Click the image for more detail. But on the other hand it also has CN¥1.19b in cash, leading to a CN¥184.0m net cash position.

How Strong Is Jiangsu Asia-Pacific Light Alloy Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jiangsu Asia-Pacific Light Alloy Technology had liabilities of CN¥731.8m due within 12 months and liabilities of CN¥1.09b due beyond that. On the other hand, it had cash of CN¥1.19b and CN¥2.34b worth of receivables due within a year. So it actually has CN¥1.71b more liquid assets than total liabilities.

This surplus suggests that Jiangsu Asia-Pacific Light Alloy Technology is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Jiangsu Asia-Pacific Light Alloy Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

Also positive, Jiangsu Asia-Pacific Light Alloy Technology grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Jiangsu Asia-Pacific Light Alloy Technology'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Jiangsu Asia-Pacific Light Alloy Technology 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, Jiangsu Asia-Pacific Light Alloy Technology 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 Jiangsu Asia-Pacific Light Alloy Technology has net cash of CN¥184.0m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 26% over the last year. So is Jiangsu Asia-Pacific Light Alloy Technology'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. Case in point: We've spotted 2 warning signs for Jiangsu Asia-Pacific Light Alloy Technology you should be aware of.

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.