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.' 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 note that AVIC Jonhon Optronic Technology Co.,Ltd. (SZSE:002179) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 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 AVIC Jonhon Optronic TechnologyLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that AVIC Jonhon Optronic TechnologyLtd had CN¥1.01b of debt in September 2024, down from CN¥1.25b, one year before. However, it does have CN¥8.00b in cash offsetting this, leading to net cash of CN¥6.99b.

A Look At AVIC Jonhon Optronic TechnologyLtd's Liabilities

We can see from the most recent balance sheet that AVIC Jonhon Optronic TechnologyLtd had liabilities of CN¥13.1b falling due within a year, and liabilities of CN¥876.6m due beyond that. Offsetting this, it had CN¥8.00b in cash and CN¥15.3b in receivables that were due within 12 months. So it actually has CN¥9.29b more liquid assets than total liabilities.

This surplus suggests that AVIC Jonhon Optronic TechnologyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, AVIC Jonhon Optronic TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that AVIC Jonhon Optronic TechnologyLtd has seen its EBIT plunge 13% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine AVIC Jonhon Optronic TechnologyLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While AVIC Jonhon Optronic 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. Looking at the most recent three years, AVIC Jonhon Optronic TechnologyLtd recorded free cash flow of 21% of its EBIT, which is weaker 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 AVIC Jonhon Optronic TechnologyLtd has net cash of CN¥6.99b, as well as more liquid assets than liabilities. So we are not troubled with AVIC Jonhon Optronic TechnologyLtd's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - AVIC Jonhon Optronic TechnologyLtd has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.