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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Jiangsu Tongli Risheng Machinery Co., Ltd. (SHSE:605286) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Jiangsu Tongli Risheng Machinery's Net Debt?

The image below, which you can click on for greater detail, shows that Jiangsu Tongli Risheng Machinery had debt of CN¥171.8m at the end of March 2024, a reduction from CN¥240.0m over a year. However, it does have CN¥658.9m in cash offsetting this, leading to net cash of CN¥487.1m.

How Strong Is Jiangsu Tongli Risheng Machinery's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jiangsu Tongli Risheng Machinery had liabilities of CN¥1.57b due within 12 months and liabilities of CN¥74.9m due beyond that. Offsetting this, it had CN¥658.9m in cash and CN¥1.18b in receivables that were due within 12 months. So it actually has CN¥196.0m more liquid assets than total liabilities.

This surplus suggests that Jiangsu Tongli Risheng Machinery has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Jiangsu Tongli Risheng Machinery has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Jiangsu Tongli Risheng Machinery grew its EBIT by 113% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Jiangsu Tongli Risheng Machinery'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Jiangsu Tongli Risheng Machinery 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. In the last three years, Jiangsu Tongli Risheng Machinery created free cash flow amounting to 11% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Jiangsu Tongli Risheng Machinery has net cash of CN¥487.1m, as well as more liquid assets than liabilities. And we liked the look of last year's 113% year-on-year EBIT growth. So we don't think Jiangsu Tongli Risheng Machinery's use of debt 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. For example - Jiangsu Tongli Risheng Machinery has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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