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.' 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. We note that Sinomach Automobile Co.,Ltd. (SHSE:600335) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Sinomach AutomobileLtd Carry?

The image below, which you can click on for greater detail, shows that Sinomach AutomobileLtd had debt of CN¥1.70b at the end of June 2024, a reduction from CN¥3.60b over a year. However, its balance sheet shows it holds CN¥3.15b in cash, so it actually has CN¥1.45b net cash.

A Look At Sinomach AutomobileLtd's Liabilities

We can see from the most recent balance sheet that Sinomach AutomobileLtd had liabilities of CN¥18.4b falling due within a year, and liabilities of CN¥1.03b due beyond that. Offsetting this, it had CN¥3.15b in cash and CN¥10.8b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.50b.

While this might seem like a lot, it is not so bad since Sinomach AutomobileLtd has a market capitalization of CN¥10.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Sinomach AutomobileLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Sinomach AutomobileLtd's EBIT was down 70% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is Sinomach AutomobileLtd'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Sinomach AutomobileLtd 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, Sinomach AutomobileLtd 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 Sinomach AutomobileLtd does have more liabilities than liquid assets, it also has net cash of CN¥1.45b. Despite the cash, we do find Sinomach AutomobileLtd's EBIT growth rate concerning, so we're not particularly comfortable with the stock. 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. We've identified 4 warning signs with Sinomach AutomobileLtd (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.