Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Shenzhen Microgate Technology Co., Ltd. (SZSE:300319) makes use of debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

How Much Debt Does Shenzhen Microgate Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shenzhen Microgate Technology had CN¥289.8m of debt, an increase on CN¥47.3m, over one year. However, it does have CN¥797.4m in cash offsetting this, leading to net cash of CN¥507.6m.

How Strong Is Shenzhen Microgate Technology's Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Microgate Technology had liabilities of CN¥1.83b falling due within a year, and liabilities of CN¥250.8m due beyond that. Offsetting these obligations, it had cash of CN¥797.4m as well as receivables valued at CN¥1.37b due within 12 months. So it actually has CN¥89.2m more liquid assets than total liabilities.

Having regard to Shenzhen Microgate Technology's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥12.1b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Shenzhen Microgate Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Shenzhen Microgate Technology grew its EBIT by 52% over the last twelve months, and that growth will make it easier to handle its debt. 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 Shenzhen Microgate Technology'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 Shenzhen Microgate Technology 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. During the last three years, Shenzhen Microgate Technology generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Microgate Technology has net cash of CN¥507.6m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥74m, being 90% of its EBIT. So is Shenzhen Microgate Technology's debt a risk? It doesn't seem so to us. 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, we've discovered 2 warning signs for Shenzhen Microgate Technology that you should be aware of before investing here.

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.