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.' 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. As with many other companies Shenyang Machine Tool Co., Ltd. (SZSE:000410) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Shenyang Machine Tool's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shenyang Machine Tool had CN¥1.23b of debt, an increase on CN¥150.1m, over one year. However, it does have CN¥251.6m in cash offsetting this, leading to net debt of about CN¥978.6m.

A Look At Shenyang Machine Tool's Liabilities

According to the last reported balance sheet, Shenyang Machine Tool had liabilities of CN¥1.90b due within 12 months, and liabilities of CN¥432.2m due beyond 12 months. Offsetting these obligations, it had cash of CN¥251.6m as well as receivables valued at CN¥729.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.35b.

Given Shenyang Machine Tool has a market capitalization of CN¥13.5b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shenyang Machine Tool will need earnings to service that debt. 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.

Over 12 months, Shenyang Machine Tool made a loss at the EBIT level, and saw its revenue drop to CN¥1.4b, which is a fall of 7.1%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Shenyang Machine Tool produced an earnings before interest and tax (EBIT) loss. Indeed, it lost CN¥224m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥157m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Shenyang Machine Tool's profit, revenue, and operating cashflow have changed over the last few years.

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.