Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 China Aerospace Times Electronics CO., LTD. (SHSE:600879) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is China Aerospace Times Electronics's Debt?

As you can see below, China Aerospace Times Electronics had CN¥4.24b of debt at December 2023, down from CN¥7.05b a year prior. But it also has CN¥4.74b in cash to offset that, meaning it has CN¥493.8m net cash.

How Strong Is China Aerospace Times Electronics' Balance Sheet?

According to the last reported balance sheet, China Aerospace Times Electronics had liabilities of CN¥22.4b due within 12 months, and liabilities of CN¥436.8m due beyond 12 months. Offsetting this, it had CN¥4.74b in cash and CN¥9.47b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥8.59b.

While this might seem like a lot, it is not so bad since China Aerospace Times Electronics has a market capitalization of CN¥22.9b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, China Aerospace Times Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that China Aerospace Times Electronics grew its EBIT at 17% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China Aerospace Times Electronics'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While China Aerospace Times Electronics 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. Over the last three years, China Aerospace Times Electronics saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While China Aerospace Times Electronics does have more liabilities than liquid assets, it also has net cash of CN¥493.8m. And we liked the look of last year's 17% year-on-year EBIT growth. So we are not troubled with China Aerospace Times Electronics's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for China Aerospace Times Electronics you should be aware of.

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.