Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Shenzhen Aisidi Co., Ltd. (SZSE:002416) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Shenzhen Aisidi's Debt?

As you can see below, Shenzhen Aisidi had CN¥4.88b of debt at September 2024, down from CN¥5.85b a year prior. However, it does have CN¥5.34b in cash offsetting this, leading to net cash of CN¥463.3m.

A Look At Shenzhen Aisidi's Liabilities

We can see from the most recent balance sheet that Shenzhen Aisidi had liabilities of CN¥9.16b falling due within a year, and liabilities of CN¥40.7m due beyond that. Offsetting this, it had CN¥5.34b in cash and CN¥2.16b in receivables that were due within 12 months. So it has liabilities totalling CN¥1.69b more than its cash and near-term receivables, combined.

Of course, Shenzhen Aisidi has a market capitalization of CN¥19.2b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Shenzhen Aisidi also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Shenzhen Aisidi if management cannot prevent a repeat of the 24% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shenzhen Aisidi 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shenzhen Aisidi 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. Over the last three years, Shenzhen Aisidi actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

We could understand if investors are concerned about Shenzhen Aisidi's liabilities, but we can be reassured by the fact it has has net cash of CN¥463.3m. And it impressed us with free cash flow of CN¥1.3b, being 216% of its EBIT. So we are not troubled with Shenzhen Aisidi'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 Aisidi is showing 3 warning signs in our investment analysis , you should know about...

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.