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. Importantly, Wuxi Autowell Technology Co.,Ltd. (SHSE:688516) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

What Is Wuxi Autowell TechnologyLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Wuxi Autowell TechnologyLtd had CN¥1.96b of debt, an increase on CN¥454.5m, over one year. However, its balance sheet shows it holds CN¥2.43b in cash, so it actually has CN¥472.6m net cash.

How Strong Is Wuxi Autowell TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wuxi Autowell TechnologyLtd had liabilities of CN¥10.0b due within 12 months and liabilities of CN¥1.40b due beyond that. On the other hand, it had cash of CN¥2.43b and CN¥2.87b worth of receivables due within a year. So it has liabilities totalling CN¥6.14b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Wuxi Autowell TechnologyLtd has a market capitalization of CN¥13.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Wuxi Autowell TechnologyLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Wuxi Autowell TechnologyLtd has boosted its EBIT by 82%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Wuxi Autowell TechnologyLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Wuxi Autowell TechnologyLtd 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. Over the last three years, Wuxi Autowell TechnologyLtd reported free cash flow worth 7.2% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

Although Wuxi Autowell TechnologyLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥472.6m. And it impressed us with its EBIT growth of 82% over the last year. So we don't have any problem with Wuxi Autowell TechnologyLtd's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Wuxi Autowell TechnologyLtd (1 shouldn't be ignored) you should be aware of.

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