The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Zhejiang Jiemei Electronic And Technology Co., Ltd. (SZSE:002859) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Zhejiang Jiemei Electronic And Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Zhejiang Jiemei Electronic And Technology had debt of CN¥2.11b, up from CN¥1.57b in one year. However, it also had CN¥664.4m in cash, and so its net debt is CN¥1.45b.

How Healthy Is Zhejiang Jiemei Electronic And Technology's Balance Sheet?

The latest balance sheet data shows that Zhejiang Jiemei Electronic And Technology had liabilities of CN¥944.4m due within a year, and liabilities of CN¥1.56b falling due after that. Offsetting these obligations, it had cash of CN¥664.4m as well as receivables valued at CN¥557.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.29b.

Given Zhejiang Jiemei Electronic And Technology has a market capitalization of CN¥7.15b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Zhejiang Jiemei Electronic And Technology's net debt is 3.1 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 36.0 is very high, suggesting that the interest expense on the debt is currently quite low. Notably, Zhejiang Jiemei Electronic And Technology's EBIT launched higher than Elon Musk, gaining a whopping 160% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Zhejiang Jiemei Electronic And Technology'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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Zhejiang Jiemei Electronic And Technology saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Zhejiang Jiemei Electronic And Technology's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that Zhejiang Jiemei Electronic And Technology is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. To that end, you should learn about the 2 warning signs we've spotted with Zhejiang Jiemei Electronic And Technology (including 1 which shouldn't be ignored) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.