Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Sinosteel Luonai Materials Technology Co., Ltd. (SHSE:688119) makes use of debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Sinosteel Luonai Materials Technology's Net Debt?

The chart below, which you can click on for greater detail, shows that Sinosteel Luonai Materials Technology had CN¥626.9m in debt in March 2024; about the same as the year before. But on the other hand it also has CN¥1.92b in cash, leading to a CN¥1.29b net cash position.

How Strong Is Sinosteel Luonai Materials Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sinosteel Luonai Materials Technology had liabilities of CN¥1.70b due within 12 months and liabilities of CN¥709.5m due beyond that. Offsetting this, it had CN¥1.92b in cash and CN¥1.47b in receivables that were due within 12 months. So it can boast CN¥976.6m more liquid assets than total liabilities.

This excess liquidity suggests that Sinosteel Luonai Materials Technology is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Sinosteel Luonai Materials Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Sinosteel Luonai Materials Technology's saving grace is its low debt levels, because its EBIT has tanked 84% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sinosteel Luonai Materials Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Sinosteel Luonai Materials 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 Luonai Materials Technology 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

While we empathize with investors who find debt concerning, you should keep in mind that Sinosteel Luonai Materials Technology has net cash of CN¥1.29b, as well as more liquid assets than liabilities. So we don't have any problem with Sinosteel Luonai Materials Technology's use of debt. 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 4 warning signs for Sinosteel Luonai Materials Technology (1 is concerning) 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.