David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Bear Electric Appliance Co.,Ltd. (SZSE:002959) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 examine debt levels, we first consider both cash and debt levels, together.

What Is Bear Electric ApplianceLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Bear Electric ApplianceLtd had CN¥498.6m of debt in March 2024, down from CN¥569.5m, one year before. However, it does have CN¥3.12b in cash offsetting this, leading to net cash of CN¥2.62b.

A Look At Bear Electric ApplianceLtd's Liabilities

The latest balance sheet data shows that Bear Electric ApplianceLtd had liabilities of CN¥2.01b due within a year, and liabilities of CN¥481.4m falling due after that. On the other hand, it had cash of CN¥3.12b and CN¥120.2m worth of receivables due within a year. So it actually has CN¥754.1m more liquid assets than total liabilities.

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

In fact Bear Electric ApplianceLtd's saving grace is its low debt levels, because its EBIT has tanked 22% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Bear Electric ApplianceLtd'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Bear Electric ApplianceLtd 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. Looking at the most recent three years, Bear Electric ApplianceLtd recorded free cash flow of 38% 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 Bear Electric ApplianceLtd has net cash of CN¥2.62b, as well as more liquid assets than liabilities. So we are not troubled with Bear Electric ApplianceLtd's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Bear Electric ApplianceLtd (of which 1 makes us a bit uncomfortable!) you should know about.

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.

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