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. We can see that Aerospace CH UAV Co.,Ltd (SZSE:002389) does use debt in its business. But the more important question is: how much risk is that debt creating?

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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Aerospace CH UAVLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Aerospace CH UAVLtd had CN¥216.8m of debt in September 2024, down from CN¥240.7m, one year before. But it also has CN¥1.29b in cash to offset that, meaning it has CN¥1.07b net cash.

How Healthy Is Aerospace CH UAVLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Aerospace CH UAVLtd had liabilities of CN¥1.81b due within 12 months and liabilities of CN¥153.2m due beyond that. On the other hand, it had cash of CN¥1.29b and CN¥2.98b worth of receivables due within a year. So it can boast CN¥2.31b more liquid assets than total liabilities.

This short term liquidity is a sign that Aerospace CH UAVLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Aerospace CH UAVLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Aerospace CH UAVLtd's load is not too heavy, because its EBIT was down 63% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Aerospace CH UAVLtd 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. Aerospace CH UAVLtd 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, Aerospace CH UAVLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Aerospace CH UAVLtd has net cash of CN¥1.07b, as well as more liquid assets than liabilities. So while Aerospace CH UAVLtd 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. We've identified 2 warning signs with Aerospace CH UAVLtd , and understanding them should be part of your investment process.

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.