Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Shanghai Tongji Science&Technology Industrial Co.,Ltd (SHSE:600846) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shanghai Tongji Science&Technology IndustrialLtd

What Is Shanghai Tongji Science&Technology IndustrialLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Shanghai Tongji Science&Technology IndustrialLtd had debt of CN¥1.52b, up from CN¥1.14b in one year. But it also has CN¥3.23b in cash to offset that, meaning it has CN¥1.71b net cash.

A Look At Shanghai Tongji Science&Technology IndustrialLtd's Liabilities

The latest balance sheet data shows that Shanghai Tongji Science&Technology IndustrialLtd had liabilities of CN¥4.86b due within a year, and liabilities of CN¥38.3m falling due after that. On the other hand, it had cash of CN¥3.23b and CN¥1.92b worth of receivables due within a year. So it can boast CN¥253.4m more liquid assets than total liabilities.

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

Another good sign is that Shanghai Tongji Science&Technology IndustrialLtd has been able to increase its EBIT by 26% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shanghai Tongji Science&Technology IndustrialLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Shanghai Tongji Science&Technology IndustrialLtd 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. Happily for any shareholders, Shanghai Tongji Science&Technology IndustrialLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Tongji Science&Technology IndustrialLtd has net cash of CN¥1.71b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of -CN¥1.2b, being 158% of its EBIT. So we don't think Shanghai Tongji Science&Technology IndustrialLtd'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. We've identified 2 warning signs with Shanghai Tongji Science&Technology IndustrialLtd (at least 1 which is potentially serious) , 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.