Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Shanghai Aohua Photoelectricity Endoscope Co., Ltd. (SHSE:688212) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Shanghai Aohua Photoelectricity Endoscope's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Shanghai Aohua Photoelectricity Endoscope had CN¥17.2m of debt, an increase on none, over one year. But it also has CN¥521.2m in cash to offset that, meaning it has CN¥504.0m net cash.

How Healthy Is Shanghai Aohua Photoelectricity Endoscope's Balance Sheet?

The latest balance sheet data shows that Shanghai Aohua Photoelectricity Endoscope had liabilities of CN¥116.6m due within a year, and liabilities of CN¥54.6m falling due after that. Offsetting this, it had CN¥521.2m in cash and CN¥179.4m in receivables that were due within 12 months. So it actually has CN¥529.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Shanghai Aohua Photoelectricity Endoscope could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shanghai Aohua Photoelectricity Endoscope boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Shanghai Aohua Photoelectricity Endoscope turned things around in the last 12 months, delivering and EBIT of CN¥54m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Aohua Photoelectricity Endoscope'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. While Shanghai Aohua Photoelectricity Endoscope 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. Over the last year, Shanghai Aohua Photoelectricity Endoscope saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shanghai Aohua Photoelectricity Endoscope has CN¥504.0m in net cash and a decent-looking balance sheet. So we are not troubled with Shanghai Aohua Photoelectricity Endoscope's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Shanghai Aohua Photoelectricity Endoscope's earnings per share history for free.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.