Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Shaanxi Huada Science Technology Co.,Ltd. (SZSE:301517) does use debt in its business. 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Shaanxi Huada Science TechnologyLtd's Debt?

The image below, which you can click on for greater detail, shows that Shaanxi Huada Science TechnologyLtd had debt of CN¥288.7m at the end of September 2024, a reduction from CN¥422.8m over a year. But it also has CN¥566.9m in cash to offset that, meaning it has CN¥278.2m net cash.

How Healthy Is Shaanxi Huada Science TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shaanxi Huada Science TechnologyLtd had liabilities of CN¥607.7m due within 12 months and liabilities of CN¥205.9m due beyond that. Offsetting these obligations, it had cash of CN¥566.9m as well as receivables valued at CN¥818.8m due within 12 months. So it can boast CN¥572.2m more liquid assets than total liabilities.

This surplus suggests that Shaanxi Huada Science TechnologyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shaanxi Huada Science TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Shaanxi Huada Science TechnologyLtd if management cannot prevent a repeat of the 57% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shaanxi Huada Science TechnologyLtd can strengthen its balance sheet over time. 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 Shaanxi Huada Science TechnologyLtd 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. During the last three years, Shaanxi Huada Science TechnologyLtd burned a lot of cash. 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

While it is always sensible to investigate a company's debt, in this case Shaanxi Huada Science TechnologyLtd has CN¥278.2m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Shaanxi Huada Science TechnologyLtd's balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Shaanxi Huada Science TechnologyLtd has 2 warning signs 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.