Warren Buffett famously said, '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. Importantly, Shenzhen Zhaowei Machinery & Electronics Co., Ltd. (SZSE:003021) does carry debt. But is this debt a concern to shareholders?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Shenzhen Zhaowei Machinery & Electronics's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Shenzhen Zhaowei Machinery & Electronics had CN¥37.5m of debt, an increase on CN¥33.0m, over one year. However, it does have CN¥982.5m in cash offsetting this, leading to net cash of CN¥944.9m.

A Look At Shenzhen Zhaowei Machinery & Electronics' Liabilities

Zooming in on the latest balance sheet data, we can see that Shenzhen Zhaowei Machinery & Electronics had liabilities of CN¥603.0m due within 12 months and liabilities of CN¥80.1m due beyond that. Offsetting this, it had CN¥982.5m in cash and CN¥394.0m in receivables that were due within 12 months. So it can boast CN¥693.4m more liquid assets than total liabilities.

This surplus suggests that Shenzhen Zhaowei Machinery & Electronics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shenzhen Zhaowei Machinery & Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Shenzhen Zhaowei Machinery & Electronics grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. 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 Zhaowei Machinery & 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 company can only pay off debt with cold hard cash, not accounting profits. Shenzhen Zhaowei Machinery & Electronics may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Considering the last three years, Shenzhen Zhaowei Machinery & Electronics actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen Zhaowei Machinery & Electronics has CN¥944.9m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 43% over the last year. So we don't have any problem with Shenzhen Zhaowei Machinery & Electronics's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Shenzhen Zhaowei Machinery & Electronics is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.