Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Suzhou Secote Precision Electronic Co.,LTD (SHSE:603283) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Suzhou Secote Precision ElectronicLTD Carry?

As you can see below, Suzhou Secote Precision ElectronicLTD had CN¥739.0m of debt at June 2024, down from CN¥1.14b a year prior. However, because it has a cash reserve of CN¥612.6m, its net debt is less, at about CN¥126.3m.

A Look At Suzhou Secote Precision ElectronicLTD's Liabilities

The latest balance sheet data shows that Suzhou Secote Precision ElectronicLTD had liabilities of CN¥2.81b due within a year, and liabilities of CN¥101.4m falling due after that. On the other hand, it had cash of CN¥612.6m and CN¥1.24b worth of receivables due within a year. So its liabilities total CN¥1.06b more than the combination of its cash and short-term receivables.

Since publicly traded Suzhou Secote Precision ElectronicLTD shares are worth a total of CN¥10.9b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Suzhou Secote Precision ElectronicLTD has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Suzhou Secote Precision ElectronicLTD has a low net debt to EBITDA ratio of only 0.13. And its EBIT covers its interest expense a whopping 161 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that Suzhou Secote Precision ElectronicLTD grew its EBIT by 148% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Suzhou Secote Precision ElectronicLTD's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Suzhou Secote Precision ElectronicLTD's free cash flow amounted to 39% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, Suzhou Secote Precision ElectronicLTD's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Looking at the bigger picture, we think Suzhou Secote Precision ElectronicLTD's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. For example, we've discovered 1 warning sign for Suzhou Secote Precision ElectronicLTD that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.