Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Micro-Tech (Nanjing) Co.,Ltd (SHSE:688029) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Micro-Tech (Nanjing)Ltd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Micro-Tech (Nanjing)Ltd had CN¥54.1m of debt, an increase on none, over one year. But it also has CN¥1.29b in cash to offset that, meaning it has CN¥1.24b net cash.

How Strong Is Micro-Tech (Nanjing)Ltd's Balance Sheet?

According to the last reported balance sheet, Micro-Tech (Nanjing)Ltd had liabilities of CN¥551.8m due within 12 months, and liabilities of CN¥68.5m due beyond 12 months. On the other hand, it had cash of CN¥1.29b and CN¥358.1m worth of receivables due within a year. So it can boast CN¥1.03b more liquid assets than total liabilities.

This short term liquidity is a sign that Micro-Tech (Nanjing)Ltd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Micro-Tech (Nanjing)Ltd has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Micro-Tech (Nanjing)Ltd grew its EBIT by 115% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Micro-Tech (Nanjing)Ltd's ability to maintain a healthy balance sheet going forward. 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. While Micro-Tech (Nanjing)Ltd 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. Looking at the most recent three years, Micro-Tech (Nanjing)Ltd recorded free cash flow of 21% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Micro-Tech (Nanjing)Ltd has net cash of CN¥1.24b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 115% over the last year. So we don't think Micro-Tech (Nanjing)Ltd's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Micro-Tech (Nanjing)Ltd .

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.