Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Shaanxi Huada Science Technology Co.,Ltd. (SZSE:301517) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Shaanxi Huada Science TechnologyLtd's Debt?

The image below, which you can click on for greater detail, shows that Shaanxi Huada Science TechnologyLtd had debt of CN¥333.7m at the end of March 2024, a reduction from CN¥412.8m over a year. But on the other hand it also has CN¥592.3m in cash, leading to a CN¥258.6m net cash position.

How Healthy Is Shaanxi Huada Science TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shaanxi Huada Science TechnologyLtd had liabilities of CN¥754.8m due within 12 months and liabilities of CN¥182.0m due beyond that. On the other hand, it had cash of CN¥592.3m and CN¥904.0m worth of receivables due within a year. So it can boast CN¥559.5m more liquid assets than total liabilities.

This surplus suggests that Shaanxi Huada Science TechnologyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shaanxi Huada Science TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Shaanxi Huada Science TechnologyLtd has seen its EBIT plunge 20% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shaanxi Huada Science TechnologyLtd'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shaanxi Huada Science TechnologyLtd 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, Shaanxi Huada Science TechnologyLtd 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 it is always sensible to investigate a company's debt, in this case Shaanxi Huada Science TechnologyLtd has CN¥258.6m in net cash and a decent-looking balance sheet. So while Shaanxi Huada Science TechnologyLtd does not have a great balance sheet, it's certainly not too bad. 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. We've identified 2 warning signs with Shaanxi Huada Science TechnologyLtd (at least 1 which is concerning) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com