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 note that Shanghai Flyco Electrical Appliance Co., Ltd. (SHSE:603868) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Shanghai Flyco Electrical Appliance Carry?

As you can see below, at the end of June 2024, Shanghai Flyco Electrical Appliance had CN¥14.1m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has CN¥1.17b in cash, leading to a CN¥1.15b net cash position.

How Strong Is Shanghai Flyco Electrical Appliance's Balance Sheet?

We can see from the most recent balance sheet that Shanghai Flyco Electrical Appliance had liabilities of CN¥791.4m falling due within a year, and liabilities of CN¥104.0m due beyond that. Offsetting this, it had CN¥1.17b in cash and CN¥370.2m in receivables that were due within 12 months. So it can boast CN¥640.6m more liquid assets than total liabilities.

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

It is just as well that Shanghai Flyco Electrical Appliance's load is not too heavy, because its EBIT was down 33% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shanghai Flyco Electrical Appliance 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shanghai Flyco Electrical Appliance 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, Shanghai Flyco Electrical Appliance generated free cash flow amounting to a very robust 94% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shanghai Flyco Electrical Appliance has CN¥1.15b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in CN¥655m. So we are not troubled with Shanghai Flyco Electrical Appliance's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Shanghai Flyco Electrical Appliance you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.