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. As with many other companies Shenyang Fortune Precision Equipment Co., Ltd. (SHSE:688409) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Shenyang Fortune Precision Equipment's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Shenyang Fortune Precision Equipment had CN¥1.42b of debt, an increase on CN¥636.9m, over one year. But it also has CN¥1.71b in cash to offset that, meaning it has CN¥290.1m net cash.

How Strong Is Shenyang Fortune Precision Equipment's Balance Sheet?

We can see from the most recent balance sheet that Shenyang Fortune Precision Equipment had liabilities of CN¥1.08b falling due within a year, and liabilities of CN¥1.76b due beyond that. Offsetting these obligations, it had cash of CN¥1.71b as well as receivables valued at CN¥1.11b due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This state of affairs indicates that Shenyang Fortune Precision Equipment's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥11.5b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Shenyang Fortune Precision Equipment also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Shenyang Fortune Precision Equipment's EBIT dived 19%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Shenyang Fortune Precision Equipment's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Shenyang Fortune Precision Equipment 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. Over the last three years, Shenyang Fortune Precision Equipment saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

We could understand if investors are concerned about Shenyang Fortune Precision Equipment's liabilities, but we can be reassured by the fact it has has net cash of CN¥290.1m. So while Shenyang Fortune Precision Equipment does not have a great balance sheet, it's certainly not too bad. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Shenyang Fortune Precision Equipment has 3 warning signs (and 1 which can't be ignored) we think you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com