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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Gemac Engineering Machinery Co., Ltd. (SZSE:301048) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Gemac Engineering Machinery Carry?

The chart below, which you can click on for greater detail, shows that Gemac Engineering Machinery had CN¥254.7m in debt in March 2024; about the same as the year before. However, its balance sheet shows it holds CN¥830.8m in cash, so it actually has CN¥576.1m net cash.

How Healthy Is Gemac Engineering Machinery's Balance Sheet?

The latest balance sheet data shows that Gemac Engineering Machinery had liabilities of CN¥2.54b due within a year, and liabilities of CN¥158.5m falling due after that. Offsetting this, it had CN¥830.8m in cash and CN¥2.05b in receivables that were due within 12 months. So it can boast CN¥174.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Gemac Engineering Machinery could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Gemac Engineering Machinery boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Gemac Engineering Machinery has increased its EBIT by 3.2% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is Gemac Engineering Machinery'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Gemac Engineering Machinery 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, Gemac Engineering Machinery barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Summing Up

While it is always sensible to investigate a company's debt, in this case Gemac Engineering Machinery has CN¥576.1m in net cash and a decent-looking balance sheet. And it also grew its EBIT by 3.2% over the last year. So we don't have any problem with Gemac Engineering Machinery's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Gemac Engineering Machinery, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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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.