Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Yingkou Jinchen Machinery Co., Ltd. (SHSE:603396) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Yingkou Jinchen Machinery Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Yingkou Jinchen Machinery had CN¥661.6m of debt, an increase on CN¥410.0m, over one year. However, it does have CN¥1.24b in cash offsetting this, leading to net cash of CN¥582.5m.

How Healthy Is Yingkou Jinchen Machinery's Balance Sheet?

The latest balance sheet data shows that Yingkou Jinchen Machinery had liabilities of CN¥3.60b due within a year, and liabilities of CN¥157.6m falling due after that. Offsetting these obligations, it had cash of CN¥1.24b as well as receivables valued at CN¥1.39b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.12b.

Of course, Yingkou Jinchen Machinery has a market capitalization of CN¥5.80b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Yingkou Jinchen Machinery also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Yingkou Jinchen Machinery grew its EBIT by 62% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Yingkou Jinchen Machinery'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. While Yingkou Jinchen Machinery 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 three years, Yingkou Jinchen Machinery saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While Yingkou Jinchen Machinery does have more liabilities than liquid assets, it also has net cash of CN¥582.5m. And we liked the look of last year's 62% year-on-year EBIT growth. So we don't have any problem with Yingkou Jinchen Machinery'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. We've identified 1 warning sign with Yingkou Jinchen Machinery , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.