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 Suzhou Gold Mantis Construction Decoration Co., Ltd. (SZSE:002081) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Suzhou Gold Mantis Construction Decoration's Net Debt?

As you can see below, Suzhou Gold Mantis Construction Decoration had CN¥853.4m of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥5.68b in cash to offset that, meaning it has CN¥4.83b net cash.

A Look At Suzhou Gold Mantis Construction Decoration's Liabilities

Zooming in on the latest balance sheet data, we can see that Suzhou Gold Mantis Construction Decoration had liabilities of CN¥19.8b due within 12 months and liabilities of CN¥708.5m due beyond that. Offsetting this, it had CN¥5.68b in cash and CN¥21.4b in receivables that were due within 12 months. So it can boast CN¥6.58b more liquid assets than total liabilities.

This luscious liquidity implies that Suzhou Gold Mantis Construction Decoration's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Suzhou Gold Mantis Construction Decoration has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Suzhou Gold Mantis Construction Decoration saw its EBIT decline by 9.6% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Suzhou Gold Mantis Construction Decoration can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Suzhou Gold Mantis Construction Decoration 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. Over the last two years, Suzhou Gold Mantis Construction Decoration recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Suzhou Gold Mantis Construction Decoration has CN¥4.83b in net cash and a decent-looking balance sheet. So we don't have any problem with Suzhou Gold Mantis Construction Decoration's use of debt. 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 Suzhou Gold Mantis Construction Decoration has 2 warning signs (and 1 which is potentially serious) we think you should know about.

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.