The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Shenzhen Kinwong Electronic Co., Ltd. (SHSE:603228) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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, 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.

What Is Shenzhen Kinwong Electronic's Debt?

The image below, which you can click on for greater detail, shows that Shenzhen Kinwong Electronic had debt of CN¥1.93b at the end of September 2024, a reduction from CN¥3.59b over a year. But it also has CN¥2.78b in cash to offset that, meaning it has CN¥844.3m net cash.

How Healthy Is Shenzhen Kinwong Electronic's Balance Sheet?

According to the last reported balance sheet, Shenzhen Kinwong Electronic had liabilities of CN¥5.78b due within 12 months, and liabilities of CN¥1.73b due beyond 12 months. Offsetting this, it had CN¥2.78b in cash and CN¥4.67b in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Shenzhen Kinwong Electronic's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥24.2b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Shenzhen Kinwong Electronic also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Shenzhen Kinwong Electronic saw its EBIT decline by 2.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shenzhen Kinwong Electronic's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shenzhen Kinwong Electronic 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 three years, Shenzhen Kinwong Electronic reported free cash flow worth 19% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

We could understand if investors are concerned about Shenzhen Kinwong Electronic's liabilities, but we can be reassured by the fact it has has net cash of CN¥844.3m. So we don't have any problem with Shenzhen Kinwong Electronic's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Shenzhen Kinwong Electronic is showing 2 warning signs in our investment analysis , 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.