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 Sichuan Jiuzhou Electronic Co., Ltd. (SZSE:000801) does use debt in its business. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Sichuan Jiuzhou Electronic's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Sichuan Jiuzhou Electronic had debt of CN¥815.1m, up from CN¥539.1m in one year. However, its balance sheet shows it holds CN¥1.32b in cash, so it actually has CN¥500.0m net cash.

How Strong Is Sichuan Jiuzhou Electronic's Balance Sheet?

The latest balance sheet data shows that Sichuan Jiuzhou Electronic had liabilities of CN¥3.13b due within a year, and liabilities of CN¥315.9m falling due after that. Offsetting these obligations, it had cash of CN¥1.32b as well as receivables valued at CN¥2.99b due within 12 months. So it actually has CN¥862.7m more liquid assets than total liabilities.

This surplus suggests that Sichuan Jiuzhou Electronic has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Sichuan Jiuzhou Electronic has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Sichuan Jiuzhou Electronic's load is not too heavy, because its EBIT was down 26% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Sichuan Jiuzhou Electronic 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. Sichuan Jiuzhou Electronic 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, Sichuan Jiuzhou Electronic's free cash flow amounted to 21% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sichuan Jiuzhou Electronic has net cash of CN¥500.0m, as well as more liquid assets than liabilities. So we are not troubled with Sichuan Jiuzhou Electronic's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Sichuan Jiuzhou Electronic has 2 warning signs we think you should be aware of.

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.