Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that AVIC Shenyang Aircraft Company Limited (SHSE:600760) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is AVIC Shenyang Aircraft's Net Debt?

As you can see below, AVIC Shenyang Aircraft had CN¥100.0m of debt at March 2024, down from CN¥150.0m a year prior. But it also has CN¥8.06b in cash to offset that, meaning it has CN¥7.96b net cash.

A Look At AVIC Shenyang Aircraft's Liabilities

According to the last reported balance sheet, AVIC Shenyang Aircraft had liabilities of CN¥29.2b due within 12 months, and liabilities of CN¥3.11b due beyond 12 months. Offsetting this, it had CN¥8.06b in cash and CN¥16.2b in receivables that were due within 12 months. So it has liabilities totalling CN¥8.04b more than its cash and near-term receivables, combined.

Since publicly traded AVIC Shenyang Aircraft shares are worth a very impressive total of CN¥107.6b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, AVIC Shenyang Aircraft boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that AVIC Shenyang Aircraft has boosted its EBIT by 31%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if AVIC Shenyang Aircraft 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 company can only pay off debt with cold hard cash, not accounting profits. While AVIC Shenyang Aircraft 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, AVIC Shenyang Aircraft burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

We could understand if investors are concerned about AVIC Shenyang Aircraft's liabilities, but we can be reassured by the fact it has has net cash of CN¥7.96b. And it impressed us with its EBIT growth of 31% over the last year. So we are not troubled with AVIC Shenyang Aircraft's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for AVIC Shenyang Aircraft you should know about.

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.