Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Shenzhen Sinexcel Electric Co.,Ltd. (SZSE:300693) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Shenzhen Sinexcel ElectricLtd's Net Debt?

As you can see below, at the end of September 2024, Shenzhen Sinexcel ElectricLtd had CN¥214.6m of debt, up from CN¥183.5m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥592.4m in cash, so it actually has CN¥377.8m net cash.

How Healthy Is Shenzhen Sinexcel ElectricLtd's Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Sinexcel ElectricLtd had liabilities of CN¥1.57b falling due within a year, and liabilities of CN¥117.0m due beyond that. Offsetting these obligations, it had cash of CN¥592.4m as well as receivables valued at CN¥1.09b due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Shenzhen Sinexcel ElectricLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥8.12b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Shenzhen Sinexcel ElectricLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Shenzhen Sinexcel ElectricLtd has increased its EBIT by 10.0% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shenzhen Sinexcel ElectricLtd 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, a company can only pay off debt with cold hard cash, not accounting profits. Shenzhen Sinexcel ElectricLtd 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. Looking at the most recent three years, Shenzhen Sinexcel ElectricLtd recorded free cash flow of 26% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

We could understand if investors are concerned about Shenzhen Sinexcel ElectricLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥377.8m. On top of that, it increased its EBIT by 10.0% in the last twelve months. So we are not troubled with Shenzhen Sinexcel ElectricLtd's debt use. 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. Be aware that Shenzhen Sinexcel ElectricLtd is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...

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.

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.