David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 note that Wecome Intelligent Manufacturing Co., Ltd. (SHSE:603070) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Wecome Intelligent Manufacturing's Net Debt?

As you can see below, Wecome Intelligent Manufacturing had CN¥190.5m of debt at June 2024, down from CN¥483.7m a year prior. But it also has CN¥644.9m in cash to offset that, meaning it has CN¥454.4m net cash.

How Healthy Is Wecome Intelligent Manufacturing's Balance Sheet?

We can see from the most recent balance sheet that Wecome Intelligent Manufacturing had liabilities of CN¥865.2m falling due within a year, and liabilities of CN¥4.56m due beyond that. On the other hand, it had cash of CN¥644.9m and CN¥1.17b worth of receivables due within a year. So it can boast CN¥948.5m more liquid assets than total liabilities.

It's good to see that Wecome Intelligent Manufacturing has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Wecome Intelligent Manufacturing has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Wecome Intelligent Manufacturing if management cannot prevent a repeat of the 48% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Wecome Intelligent Manufacturing will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Wecome Intelligent Manufacturing 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. Looking at the most recent three years, Wecome Intelligent Manufacturing recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Wecome Intelligent Manufacturing has net cash of CN¥454.4m, as well as more liquid assets than liabilities. So we don't have any problem with Wecome Intelligent Manufacturing's use of debt. 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 instance, we've identified 3 warning signs for Wecome Intelligent Manufacturing (1 is potentially serious) you should be aware of.

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.