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 Shanghai STEP Electric Corporation (SZSE:002527) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Shanghai STEP Electric

How Much Debt Does Shanghai STEP Electric Carry?

You can click the graphic below for the historical numbers, but it shows that Shanghai STEP Electric had CN¥1.37b of debt in September 2023, down from CN¥1.55b, one year before. On the flip side, it has CN¥448.7m in cash leading to net debt of about CN¥921.1m.

How Strong Is Shanghai STEP Electric's Balance Sheet?

According to the last reported balance sheet, Shanghai STEP Electric had liabilities of CN¥2.41b due within 12 months, and liabilities of CN¥373.9m due beyond 12 months. On the other hand, it had cash of CN¥448.7m and CN¥1.52b worth of receivables due within a year. So its liabilities total CN¥808.8m more than the combination of its cash and short-term receivables.

Since publicly traded Shanghai STEP Electric shares are worth a total of CN¥6.20b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. There's no doubt that we learn most about debt from the balance sheet. But it is Shanghai STEP Electric's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Shanghai STEP Electric had a loss before interest and tax, and actually shrunk its revenue by 8.3%, to CN¥3.3b. We would much prefer see growth.

Caveat Emptor

Importantly, Shanghai STEP Electric had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥239m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of CN¥934m. So we do think this stock is quite risky. 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. We've identified 1 warning sign with Shanghai STEP Electric , and understanding them should be part of your investment process.

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.