David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that Sinosteel Engineering & Technology Co., Ltd. (SZSE:000928) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Sinosteel Engineering & Technology Carry?

As you can see below, Sinosteel Engineering & Technology had CN¥729.2m of debt at March 2024, down from CN¥2.03b a year prior. But on the other hand it also has CN¥7.11b in cash, leading to a CN¥6.39b net cash position.

How Healthy Is Sinosteel Engineering & Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sinosteel Engineering & Technology had liabilities of CN¥19.1b due within 12 months and liabilities of CN¥377.0m due beyond that. Offsetting these obligations, it had cash of CN¥7.11b as well as receivables valued at CN¥9.40b due within 12 months. So its liabilities total CN¥2.94b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Sinosteel Engineering & Technology is worth CN¥9.20b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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, Sinosteel Engineering & Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also good is that Sinosteel Engineering & Technology grew its EBIT at 15% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sinosteel Engineering & Technology can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Sinosteel Engineering & Technology 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, Sinosteel Engineering & Technology generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While Sinosteel Engineering & Technology does have more liabilities than liquid assets, it also has net cash of CN¥6.39b. And it impressed us with free cash flow of -CN¥541m, being 91% of its EBIT. So we don't think Sinosteel Engineering & Technology's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Sinosteel Engineering & Technology you should be aware of, and 1 of them can't be ignored.

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.