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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Sichuan Mingxing Electric Power Co., Ltd. (SHSE:600101) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Sichuan Mingxing Electric Power Carry?

The chart below, which you can click on for greater detail, shows that Sichuan Mingxing Electric Power had CN¥80.0m in debt in March 2024; about the same as the year before. However, its balance sheet shows it holds CN¥968.1m in cash, so it actually has CN¥888.1m net cash.

How Healthy Is Sichuan Mingxing Electric Power's Balance Sheet?

The latest balance sheet data shows that Sichuan Mingxing Electric Power had liabilities of CN¥844.0m due within a year, and liabilities of CN¥304.4m falling due after that. Offsetting these obligations, it had cash of CN¥968.1m as well as receivables valued at CN¥178.0m due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Sichuan Mingxing Electric Power's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥7.27b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Sichuan Mingxing Electric Power boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Sichuan Mingxing Electric Power saw its EBIT decline by 5.7% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sichuan Mingxing Electric Power'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Sichuan Mingxing Electric Power 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. In the last three years, Sichuan Mingxing Electric Power's free cash flow amounted to 26% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

We could understand if investors are concerned about Sichuan Mingxing Electric Power's liabilities, but we can be reassured by the fact it has has net cash of CN¥888.1m. So we are not troubled with Sichuan Mingxing Electric Power's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Sichuan Mingxing Electric Power has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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.

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