The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Suzhou Alton Electrical & Mechanical Industry Co., Ltd. (SZSE:301187) does have debt on its balance sheet. But is this debt a concern to shareholders?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Suzhou Alton Electrical & Mechanical Industry's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Suzhou Alton Electrical & Mechanical Industry had debt of CN¥489.5m, up from CN¥141.3m in one year. However, it does have CN¥1.32b in cash offsetting this, leading to net cash of CN¥833.7m.

A Look At Suzhou Alton Electrical & Mechanical Industry's Liabilities

The latest balance sheet data shows that Suzhou Alton Electrical & Mechanical Industry had liabilities of CN¥1.14b due within a year, and liabilities of CN¥99.5m falling due after that. Offsetting these obligations, it had cash of CN¥1.32b as well as receivables valued at CN¥191.0m due within 12 months. So it can boast CN¥272.1m more liquid assets than total liabilities.

This surplus suggests that Suzhou Alton Electrical & Mechanical Industry has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Suzhou Alton Electrical & Mechanical Industry has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Suzhou Alton Electrical & Mechanical Industry grew its EBIT by 218% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Suzhou Alton Electrical & Mechanical Industry can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Suzhou Alton Electrical & Mechanical Industry 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, Suzhou Alton Electrical & Mechanical Industry burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Suzhou Alton Electrical & Mechanical Industry has net cash of CN¥833.7m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 218% over the last year. So we are not troubled with Suzhou Alton Electrical & Mechanical Industry'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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Suzhou Alton Electrical & Mechanical Industry (of which 2 don't sit too well with us!) 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.