The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Shanghai Awinic Technology Co.,Ltd. (SHSE:688798) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Shanghai Awinic TechnologyLtd Carry?

You can click the graphic below for the historical numbers, but it shows that Shanghai Awinic TechnologyLtd had CN¥577.5m of debt in March 2024, down from CN¥686.2m, one year before. But it also has CN¥2.62b in cash to offset that, meaning it has CN¥2.04b net cash.

How Strong Is Shanghai Awinic TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Shanghai Awinic TechnologyLtd had liabilities of CN¥1.01b due within 12 months, and liabilities of CN¥233.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.62b as well as receivables valued at CN¥81.6m due within 12 months. So it actually has CN¥1.46b more liquid assets than total liabilities.

This short term liquidity is a sign that Shanghai Awinic TechnologyLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Shanghai Awinic TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Although Shanghai Awinic TechnologyLtd made a loss at the EBIT level, last year, it was also good to see that it generated CN¥9.6m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Awinic TechnologyLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shanghai Awinic TechnologyLtd 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. Happily for any shareholders, Shanghai Awinic TechnologyLtd actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Awinic TechnologyLtd has net cash of CN¥2.04b, as well as more liquid assets than liabilities. The cherry on top was that in converted 4,493% of that EBIT to free cash flow, bringing in CN¥430m. So we don't think Shanghai Awinic TechnologyLtd's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Shanghai Awinic TechnologyLtd, you may well want to click here to check an interactive graph of its earnings per share history.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com