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.' 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 Shenzhen Inovance Technology Co.,Ltd (SZSE:300124) 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Inovance TechnologyLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Shenzhen Inovance TechnologyLtd had CN¥4.87b of debt, an increase on CN¥4.24b, over one year. However, it does have CN¥7.94b in cash offsetting this, leading to net cash of CN¥3.07b.

How Healthy Is Shenzhen Inovance TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen Inovance TechnologyLtd had liabilities of CN¥19.9b due within 12 months and liabilities of CN¥4.96b due beyond that. On the other hand, it had cash of CN¥7.94b and CN¥15.2b worth of receivables due within a year. So it has liabilities totalling CN¥1.65b more than its cash and near-term receivables, combined.

Having regard to Shenzhen Inovance TechnologyLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥115.8b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Shenzhen Inovance TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Shenzhen Inovance TechnologyLtd grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Shenzhen Inovance TechnologyLtd 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 Inovance TechnologyLtd 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. Looking at the most recent three years, Shenzhen Inovance TechnologyLtd recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

We could understand if investors are concerned about Shenzhen Inovance TechnologyLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥3.07b. And it impressed us with its EBIT growth of 23% over the last year. So is Shenzhen Inovance TechnologyLtd's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Shenzhen Inovance TechnologyLtd that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.