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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that China Security Co., Ltd. (SHSE:600654) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is China Security's Debt?

As you can see below, China Security had CN¥218.6m of debt at September 2024, down from CN¥287.5m a year prior. But on the other hand it also has CN¥547.7m in cash, leading to a CN¥329.2m net cash position.

How Healthy Is China Security's Balance Sheet?

We can see from the most recent balance sheet that China Security had liabilities of CN¥1.68b falling due within a year, and liabilities of CN¥270.6m due beyond that. Offsetting these obligations, it had cash of CN¥547.7m as well as receivables valued at CN¥1.58b due within 12 months. So it can boast CN¥175.5m more liquid assets than total liabilities.

Having regard to China Security's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥12.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that China Security 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, China Security turned things around in the last 12 months, delivering and EBIT of CN¥61m. There's no doubt that we learn most about debt from the balance sheet. But it is China Security'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While China Security 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 year, China Security 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 we empathize with investors who find debt concerning, you should keep in mind that China Security has net cash of CN¥329.2m, as well as more liquid assets than liabilities. So we don't have any problem with China Security's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - China Security has 2 warning signs 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.