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 Shenzhen Capchem Technology Co., Ltd. (SZSE:300037) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Shenzhen Capchem Technology Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Shenzhen Capchem Technology had debt of CN¥3.15b, up from CN¥2.58b in one year. However, it does have CN¥3.77b in cash offsetting this, leading to net cash of CN¥614.6m.

How Strong Is Shenzhen Capchem Technology's Balance Sheet?

The latest balance sheet data shows that Shenzhen Capchem Technology had liabilities of CN¥4.44b due within a year, and liabilities of CN¥2.66b falling due after that. On the other hand, it had cash of CN¥3.77b and CN¥3.56b worth of receivables due within a year. So it actually has CN¥229.1m more liquid assets than total liabilities.

This state of affairs indicates that Shenzhen Capchem Technology's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥23.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Shenzhen Capchem Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Shenzhen Capchem Technology's load is not too heavy, because its EBIT was down 36% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shenzhen Capchem Technology'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shenzhen Capchem Technology 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, Shenzhen Capchem Technology recorded free cash flow of 21% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Capchem Technology has net cash of CN¥614.6m, as well as more liquid assets than liabilities. So we don't have any problem with Shenzhen Capchem Technology's use of debt. 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. For instance, we've identified 1 warning sign for Shenzhen Capchem Technology that you should be aware of.

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.