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 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. As with many other companies Shenzhen VMAX New Energy Co., Ltd. (SHSE:688612) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. 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. 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 VMAX New Energy's Debt?

As you can see below, Shenzhen VMAX New Energy had CN¥569.5m of debt at March 2024, down from CN¥607.2m a year prior. However, its balance sheet shows it holds CN¥2.56b in cash, so it actually has CN¥1.99b net cash.

A Look At Shenzhen VMAX New Energy's Liabilities

Zooming in on the latest balance sheet data, we can see that Shenzhen VMAX New Energy had liabilities of CN¥3.35b due within 12 months and liabilities of CN¥363.9m due beyond that. On the other hand, it had cash of CN¥2.56b and CN¥1.98b worth of receivables due within a year. So it actually has CN¥825.0m more liquid assets than total liabilities.

This surplus suggests that Shenzhen VMAX New Energy has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shenzhen VMAX New Energy has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Shenzhen VMAX New Energy has boosted its EBIT by 61%, thus reducing the spectre of future debt repayments. 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 VMAX New Energy'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shenzhen VMAX New Energy 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. During the last three years, Shenzhen VMAX New Energy burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen VMAX New Energy has CN¥1.99b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 61% over the last year. So we are not troubled with Shenzhen VMAX New Energy's debt use. 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. For example, we've discovered 2 warning signs for Shenzhen VMAX New Energy (1 is a bit concerning!) that you should be aware of before investing here.

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.