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 Jiangxi Welgao Electronics Co., Ltd. (SZSE:301251) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Jiangxi Welgao Electronics's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Jiangxi Welgao Electronics had CN¥301.9m of debt, an increase on CN¥160.8m, over one year. However, it does have CN¥959.1m in cash offsetting this, leading to net cash of CN¥657.2m.

How Strong Is Jiangxi Welgao Electronics' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jiangxi Welgao Electronics had liabilities of CN¥836.5m due within 12 months and liabilities of CN¥6.49m due beyond that. Offsetting these obligations, it had cash of CN¥959.1m as well as receivables valued at CN¥300.5m due within 12 months. So it can boast CN¥416.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Jiangxi Welgao Electronics could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Jiangxi Welgao Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Jiangxi Welgao Electronics's load is not too heavy, because its EBIT was down 57% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is Jiangxi Welgao Electronics's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Jiangxi Welgao Electronics 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. Over the last three years, Jiangxi Welgao Electronics saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Jiangxi Welgao Electronics has CN¥657.2m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Jiangxi Welgao Electronics's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Jiangxi Welgao Electronics (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

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.