Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Shenzhen MTC Co., Ltd. (SZSE:002429) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Shenzhen MTC's Net Debt?

The chart below, which you can click on for greater detail, shows that Shenzhen MTC had CN¥5.71b in debt in September 2023; about the same as the year before. However, its balance sheet shows it holds CN¥5.99b in cash, so it actually has CN¥282.6m net cash.

A Look At Shenzhen MTC's Liabilities

Zooming in on the latest balance sheet data, we can see that Shenzhen MTC had liabilities of CN¥10.1b due within 12 months and liabilities of CN¥3.48b due beyond that. On the other hand, it had cash of CN¥5.99b and CN¥7.99b worth of receivables due within a year. So it can boast CN¥380.6m more liquid assets than total liabilities.

This state of affairs indicates that Shenzhen MTC's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥22.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Shenzhen MTC 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, Shenzhen MTC turned things around in the last 12 months, delivering and EBIT of CN¥1.6b. 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 Shenzhen MTC'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. Shenzhen MTC 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. Over the last year, Shenzhen MTC actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen MTC has CN¥282.6m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥1.7b, being 110% of its EBIT. So we don't think Shenzhen MTC's use of debt is risky. 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 Shenzhen MTC .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.