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 Shanghai Automobile Air-Conditioner Accessories Co., Ltd. (SHSE:603107) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is Shanghai Automobile Air-Conditioner Accessories's Net Debt?

As you can see below, Shanghai Automobile Air-Conditioner Accessories had CN¥193.6m of debt at December 2023, down from CN¥259.9m a year prior. But it also has CN¥1.12b in cash to offset that, meaning it has CN¥924.4m net cash.

How Strong Is Shanghai Automobile Air-Conditioner Accessories' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shanghai Automobile Air-Conditioner Accessories had liabilities of CN¥658.0m due within 12 months and liabilities of CN¥168.0m due beyond that. Offsetting these obligations, it had cash of CN¥1.12b as well as receivables valued at CN¥632.2m due within 12 months. So it actually has CN¥924.2m more liquid assets than total liabilities.

This surplus suggests that Shanghai Automobile Air-Conditioner Accessories has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shanghai Automobile Air-Conditioner Accessories 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 Shanghai Automobile Air-Conditioner Accessories has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is Shanghai Automobile Air-Conditioner Accessories's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shanghai Automobile Air-Conditioner Accessories 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. In the last three years, Shanghai Automobile Air-Conditioner Accessories created free cash flow amounting to 7.3% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Automobile Air-Conditioner Accessories has net cash of CN¥924.4m, as well as more liquid assets than liabilities. And we liked the look of last year's 39% year-on-year EBIT growth. So we don't think Shanghai Automobile Air-Conditioner Accessories's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Shanghai Automobile Air-Conditioner Accessories that you should be aware of before investing here.

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.