Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Neway Valve (Suzhou) Co., Ltd. (SHSE:603699) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Neway Valve (Suzhou) Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Neway Valve (Suzhou) had debt of CN¥1.30b, up from CN¥1.12b in one year. However, it does have CN¥1.52b in cash offsetting this, leading to net cash of CN¥216.9m.

A Look At Neway Valve (Suzhou)'s Liabilities

We can see from the most recent balance sheet that Neway Valve (Suzhou) had liabilities of CN¥4.26b falling due within a year, and liabilities of CN¥60.6m due beyond that. Offsetting this, it had CN¥1.52b in cash and CN¥2.56b in receivables that were due within 12 months. So it has liabilities totalling CN¥234.3m more than its cash and near-term receivables, combined.

Having regard to Neway Valve (Suzhou)'s size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥17.1b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Neway Valve (Suzhou) boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Neway Valve (Suzhou) grew its EBIT by 56% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Neway Valve (Suzhou)'s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Neway Valve (Suzhou) 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. Over the most recent three years, Neway Valve (Suzhou) recorded free cash flow worth 51% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Neway Valve (Suzhou) has CN¥216.9m in net cash. And it impressed us with its EBIT growth of 56% over the last year. So is Neway Valve (Suzhou)'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. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Neway Valve (Suzhou) that you should be aware of before investing here.

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.