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.' 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. We note that Himile Mechanical Science and Technology (Shandong) Co., Ltd (SZSE:002595) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Himile Mechanical Science and Technology (Shandong)'s Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Himile Mechanical Science and Technology (Shandong) had debt of CN¥111.6m, up from CN¥39.6m in one year. But it also has CN¥1.81b in cash to offset that, meaning it has CN¥1.70b net cash.

A Look At Himile Mechanical Science and Technology (Shandong)'s Liabilities

According to the last reported balance sheet, Himile Mechanical Science and Technology (Shandong) had liabilities of CN¥1.39b due within 12 months, and liabilities of CN¥303.2m due beyond 12 months. On the other hand, it had cash of CN¥1.81b and CN¥3.39b worth of receivables due within a year. So it can boast CN¥3.52b more liquid assets than total liabilities.

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

Another good sign is that Himile Mechanical Science and Technology (Shandong) has been able to increase its EBIT by 25% in twelve months, making it easier to pay down 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 Himile Mechanical Science and Technology (Shandong)'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. Himile Mechanical Science and Technology (Shandong) 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. In the last three years, Himile Mechanical Science and Technology (Shandong)'s free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Himile Mechanical Science and Technology (Shandong) has CN¥1.70b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 25% over the last year. So is Himile Mechanical Science and Technology (Shandong)'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. Case in point: We've spotted 1 warning sign for Himile Mechanical Science and Technology (Shandong) 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.