Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Shenzhen KSTAR Science and Technology Co., Ltd. (SZSE:002518) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

What Is Shenzhen KSTAR Science and Technology's Net Debt?

As you can see below, Shenzhen KSTAR Science and Technology had CN¥48.0m of debt at March 2024, down from CN¥64.4m a year prior. But it also has CN¥1.60b in cash to offset that, meaning it has CN¥1.55b net cash.

How Strong Is Shenzhen KSTAR Science and Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen KSTAR Science and Technology had liabilities of CN¥1.98b due within 12 months and liabilities of CN¥285.8m due beyond that. On the other hand, it had cash of CN¥1.60b and CN¥1.53b worth of receivables due within a year. So it actually has CN¥864.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Shenzhen KSTAR Science and Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shenzhen KSTAR Science and Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Shenzhen KSTAR Science and Technology's saving grace is its low debt levels, because its EBIT has tanked 25% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Shenzhen KSTAR Science and Technology 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shenzhen KSTAR Science and Technology 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. During the last three years, Shenzhen KSTAR Science and Technology produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen KSTAR Science and Technology has net cash of CN¥1.55b, as well as more liquid assets than liabilities. So we don't have any problem with Shenzhen KSTAR Science and Technology's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Shenzhen KSTAR Science and Technology you should be aware of, and 1 of them doesn't sit too well with us.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com