David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Sumec Corporation Limited (SHSE:600710) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Sumec Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Sumec had CN¥5.42b of debt, an increase on CN¥4.73b, over one year. However, its balance sheet shows it holds CN¥11.0b in cash, so it actually has CN¥5.57b net cash.

How Strong Is Sumec's Balance Sheet?

According to the last reported balance sheet, Sumec had liabilities of CN¥39.7b due within 12 months, and liabilities of CN¥2.86b due beyond 12 months. Offsetting this, it had CN¥11.0b in cash and CN¥11.8b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥19.8b.

This deficit casts a shadow over the CN¥11.3b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Sumec would likely require a major re-capitalisation if it had to pay its creditors today. Given that Sumec has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

While Sumec doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sumec'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 company can only pay off debt with cold hard cash, not accounting profits. Sumec 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. Happily for any shareholders, Sumec actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Sumec does have more liabilities than liquid assets, it also has net cash of CN¥5.57b. And it impressed us with free cash flow of CN¥1.1b, being 156% of its EBIT. So while Sumec does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Sumec that you should be aware of.

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.