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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Suzhou Good-Ark Electronics Co., Ltd. (SZSE:002079) does use debt in its business. 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. 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, 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 Suzhou Good-Ark Electronics's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Suzhou Good-Ark Electronics had debt of CN¥656.5m, up from CN¥183.3m in one year. But it also has CN¥715.0m in cash to offset that, meaning it has CN¥58.5m net cash.

How Healthy Is Suzhou Good-Ark Electronics' Balance Sheet?

According to the last reported balance sheet, Suzhou Good-Ark Electronics had liabilities of CN¥1.18b due within 12 months, and liabilities of CN¥206.0m due beyond 12 months. Offsetting this, it had CN¥715.0m in cash and CN¥1.49b in receivables that were due within 12 months. So it can boast CN¥816.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Suzhou Good-Ark Electronics could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Suzhou Good-Ark Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Suzhou Good-Ark Electronics has seen its EBIT plunge 10% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Suzhou Good-Ark Electronics will need earnings to service that debt. 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 company can only pay off debt with cold hard cash, not accounting profits. While Suzhou Good-Ark Electronics 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, Suzhou Good-Ark Electronics 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 Suzhou Good-Ark Electronics has CN¥58.5m in net cash and a decent-looking balance sheet. So we are not troubled with Suzhou Good-Ark Electronics's debt use. 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. For example - Suzhou Good-Ark Electronics has 2 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.