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.' 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. Importantly, Sensteed Hi-Tech Group (SZSE:000981) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Sensteed Hi-Tech Group Carry?

You can click the graphic below for the historical numbers, but it shows that Sensteed Hi-Tech Group had CN¥4.95b of debt in June 2024, down from CN¥5.96b, one year before. On the flip side, it has CN¥845.1m in cash leading to net debt of about CN¥4.10b.

How Healthy Is Sensteed Hi-Tech Group's Balance Sheet?

We can see from the most recent balance sheet that Sensteed Hi-Tech Group had liabilities of CN¥7.35b falling due within a year, and liabilities of CN¥2.53b due beyond that. Offsetting this, it had CN¥845.1m in cash and CN¥2.14b in receivables that were due within 12 months. So it has liabilities totalling CN¥6.90b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥9.98b, so it does suggest shareholders should keep an eye on Sensteed Hi-Tech Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sensteed Hi-Tech Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Sensteed Hi-Tech Group saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that hardly impresses, its not too bad either.

Caveat Emptor

Over the last twelve months Sensteed Hi-Tech Group produced an earnings before interest and tax (EBIT) loss. Indeed, it lost CN¥882m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of CN¥1.8b. So to be blunt we do think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Sensteed Hi-Tech Group has 2 warning signs (and 1 which is significant) we think you should know about.

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.