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.' 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. We can see that Shanghai Awinic Technology Co.,Ltd. (SHSE:688798) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

What Is Shanghai Awinic TechnologyLtd's Debt?

As you can see below, Shanghai Awinic TechnologyLtd had CN¥597.7m of debt at September 2024, down from CN¥666.7m a year prior. But on the other hand it also has CN¥2.21b in cash, leading to a CN¥1.61b net cash position.

How Strong Is Shanghai Awinic TechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Shanghai Awinic TechnologyLtd had liabilities of CN¥911.4m falling due within a year, and liabilities of CN¥163.7m due beyond that. On the other hand, it had cash of CN¥2.21b and CN¥80.2m worth of receivables due within a year. So it can boast CN¥1.22b more liquid assets than total liabilities.

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

It was also good to see that despite losing money on the EBIT line last year, Shanghai Awinic TechnologyLtd turned things around in the last 12 months, delivering and EBIT of CN¥247m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Shanghai Awinic TechnologyLtd 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. While Shanghai Awinic TechnologyLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last year, Shanghai Awinic TechnologyLtd created free cash flow amounting to 5.6% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Awinic TechnologyLtd has net cash of CN¥1.61b, as well as more liquid assets than liabilities. So we don't have any problem with Shanghai Awinic TechnologyLtd's use of debt. 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. We've identified 2 warning signs with Shanghai Awinic TechnologyLtd , and understanding them should be part of your investment process.

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.