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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Tianjin Jingwei Huikai Optoelectronic Co., Ltd. (SZSE:300120) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Tianjin Jingwei Huikai Optoelectronic's Net Debt?

The image below, which you can click on for greater detail, shows that Tianjin Jingwei Huikai Optoelectronic had debt of CN¥854.4m at the end of September 2024, a reduction from CN¥951.6m over a year. However, it does have CN¥991.8m in cash offsetting this, leading to net cash of CN¥137.4m.

How Healthy Is Tianjin Jingwei Huikai Optoelectronic's Balance Sheet?

We can see from the most recent balance sheet that Tianjin Jingwei Huikai Optoelectronic had liabilities of CN¥1.18b falling due within a year, and liabilities of CN¥452.1m due beyond that. On the other hand, it had cash of CN¥991.8m and CN¥948.0m worth of receivables due within a year. So it can boast CN¥307.8m more liquid assets than total liabilities.

This surplus suggests that Tianjin Jingwei Huikai Optoelectronic has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Tianjin Jingwei Huikai Optoelectronic has more cash than debt is arguably a good indication that it can manage its debt safely.

Importantly, Tianjin Jingwei Huikai Optoelectronic's EBIT fell a jaw-dropping 57% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tianjin Jingwei Huikai Optoelectronic's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Tianjin Jingwei Huikai Optoelectronic 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, Tianjin Jingwei Huikai Optoelectronic burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Tianjin Jingwei Huikai Optoelectronic has CN¥137.4m in net cash and a decent-looking balance sheet. Despite its cash we think that Tianjin Jingwei Huikai Optoelectronic seems to struggle to grow its EBIT, so we are wary of the stock. 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 - Tianjin Jingwei Huikai Optoelectronic has 2 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.