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 can see that Shenzhen Han's CNC Technology Co., Ltd. (SZSE:301200) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Shenzhen Han's CNC Technology Carry?

As you can see below, at the end of March 2024, Shenzhen Han's CNC Technology had CN¥568.5m of debt, up from CN¥3.96m a year ago. Click the image for more detail. But it also has CN¥2.22b in cash to offset that, meaning it has CN¥1.65b net cash.

How Strong Is Shenzhen Han's CNC Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen Han's CNC Technology had liabilities of CN¥1.82b due within 12 months and liabilities of CN¥62.7m due beyond that. On the other hand, it had cash of CN¥2.22b and CN¥2.17b worth of receivables due within a year. So it can boast CN¥2.51b more liquid assets than total liabilities.

This surplus suggests that Shenzhen Han's CNC Technology is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Shenzhen Han's CNC Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Shenzhen Han's CNC Technology's saving grace is its low debt levels, because its EBIT has tanked 80% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shenzhen Han's CNC Technology will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shenzhen Han's CNC Technology 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. In the last three years, Shenzhen Han's CNC Technology's free cash flow amounted to 24% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Han's CNC Technology has net cash of CN¥1.65b, as well as more liquid assets than liabilities. So we don't have any problem with Shenzhen Han's CNC Technology's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Shenzhen Han's CNC Technology (of which 2 are significant!) you should know about.

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.

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