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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies CMST Development Co.,Ltd. (SHSE:600787) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is CMST DevelopmentLtd's Debt?

The image below, which you can click on for greater detail, shows that CMST DevelopmentLtd had debt of CN¥2.53b at the end of September 2024, a reduction from CN¥2.95b over a year. But on the other hand it also has CN¥3.31b in cash, leading to a CN¥780.5m net cash position.

How Strong Is CMST DevelopmentLtd's Balance Sheet?

The latest balance sheet data shows that CMST DevelopmentLtd had liabilities of CN¥5.89b due within a year, and liabilities of CN¥3.11b falling due after that. On the other hand, it had cash of CN¥3.31b and CN¥5.31b worth of receivables due within a year. So its liabilities total CN¥393.1m more than the combination of its cash and short-term receivables.

Given CMST DevelopmentLtd has a market capitalization of CN¥14.6b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, CMST DevelopmentLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that CMST DevelopmentLtd has boosted its EBIT by 30%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since CMST DevelopmentLtd will need earnings to service that debt. 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. While CMST DevelopmentLtd 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. Happily for any shareholders, CMST DevelopmentLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

We could understand if investors are concerned about CMST DevelopmentLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥780.5m. And it impressed us with free cash flow of CN¥245m, being 184% of its EBIT. So we don't think CMST DevelopmentLtd's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that CMST DevelopmentLtd is showing 3 warning signs in our investment analysis , you should know about...

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.