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.' 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 Zhejiang Jingsheng Mechanical & Electrical Co., Ltd. (SZSE:300316) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. 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 Zhejiang Jingsheng Mechanical & Electrical's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Zhejiang Jingsheng Mechanical & Electrical had CN¥2.00b of debt, an increase on CN¥1.69b, over one year. However, it does have CN¥2.93b in cash offsetting this, leading to net cash of CN¥935.8m.

How Healthy Is Zhejiang Jingsheng Mechanical & Electrical's Balance Sheet?

The latest balance sheet data shows that Zhejiang Jingsheng Mechanical & Electrical had liabilities of CN¥15.5b due within a year, and liabilities of CN¥1.43b falling due after that. Offsetting these obligations, it had cash of CN¥2.93b as well as receivables valued at CN¥6.68b due within 12 months. So its liabilities total CN¥7.32b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Zhejiang Jingsheng Mechanical & Electrical is worth CN¥30.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Zhejiang Jingsheng Mechanical & Electrical also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also positive, Zhejiang Jingsheng Mechanical & Electrical grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhejiang Jingsheng Mechanical & Electrical can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Zhejiang Jingsheng Mechanical & Electrical 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, Zhejiang Jingsheng Mechanical & Electrical recorded negative free cash flow, in total. 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

Although Zhejiang Jingsheng Mechanical & Electrical's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥935.8m. And we liked the look of last year's 25% year-on-year EBIT growth. So we don't have any problem with Zhejiang Jingsheng Mechanical & Electrical's use of debt. 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 2 warning signs for Zhejiang Jingsheng Mechanical & Electrical (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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.

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