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 can see that Miracle Automation Engineering Co.Ltd (SZSE:002009) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Miracle Automation EngineeringLtd's Debt?

As you can see below, Miracle Automation EngineeringLtd had CN¥2.11b of debt at March 2024, down from CN¥2.51b a year prior. However, because it has a cash reserve of CN¥802.9m, its net debt is less, at about CN¥1.31b.

A Look At Miracle Automation EngineeringLtd's Liabilities

According to the last reported balance sheet, Miracle Automation EngineeringLtd had liabilities of CN¥3.65b due within 12 months, and liabilities of CN¥467.9m due beyond 12 months. Offsetting these obligations, it had cash of CN¥802.9m as well as receivables valued at CN¥2.05b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.26b.

This deficit isn't so bad because Miracle Automation EngineeringLtd is worth CN¥5.90b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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 Miracle Automation EngineeringLtd'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.

Over 12 months, Miracle Automation EngineeringLtd made a loss at the EBIT level, and saw its revenue drop to CN¥3.5b, which is a fall of 15%. That's not what we would hope to see.

Caveat Emptor

While Miracle Automation EngineeringLtd's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥306m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥101m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Miracle Automation EngineeringLtd (including 1 which can't be ignored) .

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.