Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Shenzhen Changhong Technology Co., Ltd. (SZSE:300151) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Shenzhen Changhong Technology Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Shenzhen Changhong Technology had debt of CN¥608.3m, up from CN¥545.1m in one year. But on the other hand it also has CN¥755.1m in cash, leading to a CN¥146.7m net cash position.

How Strong Is Shenzhen Changhong Technology's Balance Sheet?

The latest balance sheet data shows that Shenzhen Changhong Technology had liabilities of CN¥291.8m due within a year, and liabilities of CN¥555.4m falling due after that. Offsetting this, it had CN¥755.1m in cash and CN¥266.0m in receivables that were due within 12 months. So it can boast CN¥173.9m more liquid assets than total liabilities.

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

Importantly, Shenzhen Changhong Technology's EBIT fell a jaw-dropping 64% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Shenzhen Changhong Technology 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. While Shenzhen Changhong Technology has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Shenzhen Changhong Technology 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 it is always sensible to investigate a company's debt, in this case Shenzhen Changhong Technology has CN¥146.7m in net cash and a decent-looking balance sheet. Despite the cash, we do find Shenzhen Changhong Technology's EBIT growth rate concerning, so we're not particularly comfortable with the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Shenzhen Changhong Technology has 4 warning signs (and 1 which is concerning) we think 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.