The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Wuxi Hyatech Co.,Ltd. (SHSE:688510) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Wuxi HyatechLtd's Net Debt?

As you can see below, Wuxi HyatechLtd had CN¥108.8m of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥218.1m in cash to offset that, meaning it has CN¥109.3m net cash.

A Look At Wuxi HyatechLtd's Liabilities

The latest balance sheet data shows that Wuxi HyatechLtd had liabilities of CN¥453.6m due within a year, and liabilities of CN¥42.5m falling due after that. Offsetting these obligations, it had cash of CN¥218.1m as well as receivables valued at CN¥265.0m due within 12 months. So its liabilities total CN¥12.9m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Wuxi HyatechLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥4.39b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Wuxi HyatechLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Wuxi HyatechLtd grew its EBIT by 512% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Wuxi HyatechLtd can strengthen its balance sheet over time. 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 Wuxi HyatechLtd 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. Over the last two years, Wuxi HyatechLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

We could understand if investors are concerned about Wuxi HyatechLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥109.3m. And we liked the look of last year's 512% year-on-year EBIT growth. So we are not troubled with Wuxi HyatechLtd's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Wuxi HyatechLtd is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.