Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Shenzhen Envicool Technology Co., Ltd. (SZSE:002837) does carry debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Shenzhen Envicool Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shenzhen Envicool Technology had CN¥694.0m of debt, an increase on CN¥518.4m, over one year. But it also has CN¥887.4m in cash to offset that, meaning it has CN¥193.5m net cash.

How Strong Is Shenzhen Envicool Technology's Balance Sheet?

The latest balance sheet data shows that Shenzhen Envicool Technology had liabilities of CN¥2.50b due within a year, and liabilities of CN¥307.3m falling due after that. Offsetting this, it had CN¥887.4m in cash and CN¥2.45b in receivables that were due within 12 months. So it actually has CN¥533.3m more liquid assets than total liabilities.

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

In addition to that, we're happy to report that Shenzhen Envicool Technology has boosted its EBIT by 44%, thus reducing the spectre of future debt repayments. 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 Shenzhen Envicool Technology can strengthen its balance sheet over time. 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. Shenzhen Envicool Technology may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Shenzhen Envicool Technology recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Envicool Technology has net cash of CN¥193.5m, as well as more liquid assets than liabilities. And we liked the look of last year's 44% year-on-year EBIT growth. So we don't think Shenzhen Envicool Technology's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Shenzhen Envicool Technology's earnings per share history for free.

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.