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. As with many other companies Xiamen Intretech Inc. (SZSE:002925) makes use of debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Xiamen Intretech's Net Debt?

The image below, which you can click on for greater detail, shows that Xiamen Intretech had debt of CN¥819.5m at the end of June 2024, a reduction from CN¥981.9m over a year. But it also has CN¥1.44b in cash to offset that, meaning it has CN¥625.0m net cash.

A Look At Xiamen Intretech's Liabilities

According to the last reported balance sheet, Xiamen Intretech had liabilities of CN¥1.58b due within 12 months, and liabilities of CN¥311.9m due beyond 12 months. Offsetting this, it had CN¥1.44b in cash and CN¥1.16b in receivables that were due within 12 months. So it can boast CN¥707.5m more liquid assets than total liabilities.

This surplus suggests that Xiamen Intretech has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Xiamen Intretech 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 Xiamen Intretech if management cannot prevent a repeat of the 25% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Xiamen Intretech'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Xiamen Intretech 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. During the last three years, Xiamen Intretech generated free cash flow amounting to a very robust 87% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Xiamen Intretech has CN¥625.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥114m, being 87% of its EBIT. So we don't have any problem with Xiamen Intretech's use of debt. 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. Case in point: We've spotted 1 warning sign for Xiamen Intretech you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.