Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Johnson Electric Holdings Limited (HKG:179) makes use of debt. But should shareholders be worried about its use of debt?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

What Is Johnson Electric Holdings's Debt?

As you can see below, Johnson Electric Holdings had US$368.3m of debt at September 2023, down from US$471.7m a year prior. However, its balance sheet shows it holds US$461.3m in cash, so it actually has US$93.1m net cash.

How Strong Is Johnson Electric Holdings' Balance Sheet?

The latest balance sheet data shows that Johnson Electric Holdings had liabilities of US$1.21b due within a year, and liabilities of US$293.0m falling due after that. On the other hand, it had cash of US$461.3m and US$689.8m worth of receivables due within a year. So its liabilities total US$350.7m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Johnson Electric Holdings has a market capitalization of US$1.26b, 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, Johnson Electric Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Johnson Electric Holdings grew its EBIT by 329% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Johnson Electric Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Johnson Electric Holdings 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. During the last three years, Johnson Electric Holdings produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

Although Johnson Electric Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$93.1m. And we liked the look of last year's 329% year-on-year EBIT growth. So is Johnson Electric Holdings's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 1 warning sign for Johnson Electric Holdings that 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.