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 Kinco Automation (Shanghai) Co.,Ltd (SHSE:688160) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is Kinco Automation (Shanghai)Ltd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Kinco Automation (Shanghai)Ltd had CN¥100.0m of debt, an increase on CN¥30.0m, over one year. However, its balance sheet shows it holds CN¥348.7m in cash, so it actually has CN¥248.7m net cash.

A Look At Kinco Automation (Shanghai)Ltd's Liabilities

Zooming in on the latest balance sheet data, we can see that Kinco Automation (Shanghai)Ltd had liabilities of CN¥247.0m due within 12 months and liabilities of CN¥18.0m due beyond that. Offsetting these obligations, it had cash of CN¥348.7m as well as receivables valued at CN¥169.1m due within 12 months. So it actually has CN¥252.7m more liquid assets than total liabilities.

This surplus suggests that Kinco Automation (Shanghai)Ltd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Kinco Automation (Shanghai)Ltd has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Kinco Automation (Shanghai)Ltd's saving grace is its low debt levels, because its EBIT has tanked 43% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Kinco Automation (Shanghai)Ltd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Kinco Automation (Shanghai)Ltd 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. Over the last three years, Kinco Automation (Shanghai)Ltd recorded free cash flow worth a fulsome 93% of its EBIT, which is stronger than we'd usually 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 Kinco Automation (Shanghai)Ltd has net cash of CN¥248.7m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥37m, being 93% of its EBIT. So we don't have any problem with Kinco Automation (Shanghai)Ltd'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 instance, we've identified 3 warning signs for Kinco Automation (Shanghai)Ltd (2 don't sit too well with us) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.