Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Suzhou Longway Eletronic Machinery Co., Ltd (SZSE:301202) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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.

What Is Suzhou Longway Eletronic Machinery's Debt?

As you can see below, Suzhou Longway Eletronic Machinery had CN¥98.8m of debt at March 2024, down from CN¥265.2m a year prior. However, it does have CN¥69.8m in cash offsetting this, leading to net debt of about CN¥29.0m.

How Strong Is Suzhou Longway Eletronic Machinery's Balance Sheet?

We can see from the most recent balance sheet that Suzhou Longway Eletronic Machinery had liabilities of CN¥321.3m falling due within a year, and liabilities of CN¥20.5m due beyond that. Offsetting this, it had CN¥69.8m in cash and CN¥268.0m in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Suzhou Longway Eletronic Machinery's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥4.34b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Suzhou Longway Eletronic Machinery has a very light debt load indeed.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Suzhou Longway Eletronic Machinery has a low net debt to EBITDA ratio of only 0.27. And its EBIT covers its interest expense a whopping 891 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Suzhou Longway Eletronic Machinery grew its EBIT by 11% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Suzhou Longway Eletronic Machinery will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Suzhou Longway Eletronic Machinery's free cash flow amounted to 42% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Suzhou Longway Eletronic Machinery's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its net debt to EBITDA also supports that impression! When we consider the range of factors above, it looks like Suzhou Longway Eletronic Machinery is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. For example - Suzhou Longway Eletronic Machinery has 2 warning signs we think you should be aware of.

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.