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.' 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. Importantly, Bethel Automotive Safety Systems Co., Ltd (SHSE:603596) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Bethel Automotive Safety Systems's Net Debt?

The image below, which you can click on for greater detail, shows that Bethel Automotive Safety Systems had debt of CN¥517.6m at the end of March 2024, a reduction from CN¥738.5m over a year. But on the other hand it also has CN¥2.37b in cash, leading to a CN¥1.85b net cash position.

How Healthy Is Bethel Automotive Safety Systems' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Bethel Automotive Safety Systems had liabilities of CN¥4.16b due within 12 months and liabilities of CN¥495.1m due beyond that. Offsetting these obligations, it had cash of CN¥2.37b as well as receivables valued at CN¥4.14b due within 12 months. So it actually has CN¥1.86b more liquid assets than total liabilities.

This short term liquidity is a sign that Bethel Automotive Safety Systems could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Bethel Automotive Safety Systems has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Bethel Automotive Safety Systems grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its 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 Bethel Automotive Safety Systems's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Bethel Automotive Safety Systems 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. Considering the last three years, Bethel Automotive Safety Systems actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Bethel Automotive Safety Systems has net cash of CN¥1.85b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 43% over the last year. So is Bethel Automotive Safety Systems's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Bethel Automotive Safety Systems is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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