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.' 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 can see that Inner Mongolia First Machinery Group Co.,Ltd. (SHSE:600967) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

How Much Debt Does Inner Mongolia First Machinery GroupLtd Carry?

As you can see below, at the end of March 2024, Inner Mongolia First Machinery GroupLtd had CN¥43.0m of debt, up from CN¥25.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥6.27b in cash, so it actually has CN¥6.22b net cash.

How Healthy Is Inner Mongolia First Machinery GroupLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Inner Mongolia First Machinery GroupLtd had liabilities of CN¥10.5b due within 12 months and liabilities of CN¥768.0m due beyond that. Offsetting this, it had CN¥6.27b in cash and CN¥2.21b in receivables that were due within 12 months. So it has liabilities totalling CN¥2.77b more than its cash and near-term receivables, combined.

Inner Mongolia First Machinery GroupLtd has a market capitalization of CN¥12.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Inner Mongolia First Machinery GroupLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Inner Mongolia First Machinery GroupLtd grew its EBIT at 11% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Inner Mongolia First Machinery GroupLtd'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. Inner Mongolia First Machinery GroupLtd 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 last three years, Inner Mongolia First Machinery GroupLtd saw substantial negative free cash flow, in total. 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 Inner Mongolia First Machinery GroupLtd does have more liabilities than liquid assets, it also has net cash of CN¥6.22b. And it also grew its EBIT by 11% over the last year. So we don't have any problem with Inner Mongolia First Machinery GroupLtd's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Inner Mongolia First Machinery GroupLtd (of which 1 is a bit concerning!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.