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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Shenzhen Mason Technologies Co.,Ltd (SZSE:002654) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

What Is Shenzhen Mason TechnologiesLtd's Net Debt?

The chart below, which you can click on for greater detail, shows that Shenzhen Mason TechnologiesLtd had CN¥702.0m in debt in March 2024; about the same as the year before. However, because it has a cash reserve of CN¥332.3m, its net debt is less, at about CN¥369.7m.

A Look At Shenzhen Mason TechnologiesLtd's Liabilities

We can see from the most recent balance sheet that Shenzhen Mason TechnologiesLtd had liabilities of CN¥2.06b falling due within a year, and liabilities of CN¥587.7m due beyond that. Offsetting this, it had CN¥332.3m in cash and CN¥1.69b in receivables that were due within 12 months. So it has liabilities totalling CN¥622.6m more than its cash and near-term receivables, combined.

Since publicly traded Shenzhen Mason TechnologiesLtd shares are worth a total of CN¥7.56b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Shenzhen Mason TechnologiesLtd's debt is 4.2 times its EBITDA, and its EBIT cover its interest expense 2.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. One redeeming factor for Shenzhen Mason TechnologiesLtd is that it turned last year's EBIT loss into a gain of CN¥8.2m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shenzhen Mason TechnologiesLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Shenzhen Mason TechnologiesLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Mulling over Shenzhen Mason TechnologiesLtd's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But on the bright side, its level of total liabilities is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Shenzhen Mason TechnologiesLtd stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. For example, we've discovered 1 warning sign for Shenzhen Mason TechnologiesLtd that you should be aware of before investing here.

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.