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.' 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 Vanchip (Tianjin) Technology Co., Ltd. (SHSE:688153) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Vanchip (Tianjin) Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Vanchip (Tianjin) Technology had CN¥102.0m of debt, an increase on CN¥98.1m, over one year. However, it does have CN¥2.83b in cash offsetting this, leading to net cash of CN¥2.73b.

How Healthy Is Vanchip (Tianjin) Technology's Balance Sheet?

According to the last reported balance sheet, Vanchip (Tianjin) Technology had liabilities of CN¥568.0m due within 12 months, and liabilities of CN¥54.1m due beyond 12 months. On the other hand, it had cash of CN¥2.83b and CN¥454.9m worth of receivables due within a year. So it actually has CN¥2.66b more liquid assets than total liabilities.

This short term liquidity is a sign that Vanchip (Tianjin) Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Vanchip (Tianjin) Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Vanchip (Tianjin) Technology turned things around in the last 12 months, delivering and EBIT of CN¥62m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Vanchip (Tianjin) Technology'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. While Vanchip (Tianjin) Technology 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. Happily for any shareholders, Vanchip (Tianjin) Technology actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to investigate a company's debt, in this case Vanchip (Tianjin) Technology has CN¥2.73b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥187m, being 300% of its EBIT. So is Vanchip (Tianjin) Technology's debt a risk? It doesn't seem so to us. 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. We've identified 2 warning signs with Vanchip (Tianjin) Technology , and understanding them should be part of your investment process.

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.