Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Universal Scientific Industrial (Shanghai) Co., Ltd. (SHSE:601231) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Universal Scientific Industrial (Shanghai)'s Net Debt?

The chart below, which you can click on for greater detail, shows that Universal Scientific Industrial (Shanghai) had CN¥8.66b in debt in March 2024; about the same as the year before. However, it does have CN¥13.1b in cash offsetting this, leading to net cash of CN¥4.40b.

How Strong Is Universal Scientific Industrial (Shanghai)'s Balance Sheet?

The latest balance sheet data shows that Universal Scientific Industrial (Shanghai) had liabilities of CN¥17.4b due within a year, and liabilities of CN¥4.35b falling due after that. Offsetting these obligations, it had cash of CN¥13.1b as well as receivables valued at CN¥8.41b due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Universal Scientific Industrial (Shanghai)'s size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥37.8b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Universal Scientific Industrial (Shanghai) also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Universal Scientific Industrial (Shanghai)'s saving grace is its low debt levels, because its EBIT has tanked 31% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Universal Scientific Industrial (Shanghai) can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Universal Scientific Industrial (Shanghai) 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. Over the most recent three years, Universal Scientific Industrial (Shanghai) recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Universal Scientific Industrial (Shanghai) has CN¥4.40b in net cash. And it impressed us with free cash flow of CN¥3.9b, being 73% of its EBIT. So we are not troubled with Universal Scientific Industrial (Shanghai)'s debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Universal Scientific Industrial (Shanghai) 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.

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