Warren Buffett famously said, '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, Shanghai Taisheng Wind Power Equipment Co., Ltd. (SZSE:300129) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Shanghai Taisheng Wind Power Equipment's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Shanghai Taisheng Wind Power Equipment had debt of CN¥1.18b, up from CN¥332.5m in one year. However, it does have CN¥873.8m in cash offsetting this, leading to net debt of about CN¥305.6m.

How Healthy Is Shanghai Taisheng Wind Power Equipment's Balance Sheet?

We can see from the most recent balance sheet that Shanghai Taisheng Wind Power Equipment had liabilities of CN¥3.93b falling due within a year, and liabilities of CN¥554.1m due beyond that. Offsetting these obligations, it had cash of CN¥873.8m as well as receivables valued at CN¥3.54b due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Shanghai Taisheng Wind Power Equipment'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¥6.96b company is struggling for cash, we still think it's worth monitoring its balance sheet.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Shanghai Taisheng Wind Power Equipment has a low net debt to EBITDA ratio of only 0.83. And its EBIT easily covers its interest expense, being 15.3 times the size. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that Shanghai Taisheng Wind Power Equipment saw its EBIT decline by 7.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shanghai Taisheng Wind Power Equipment can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Shanghai Taisheng Wind Power Equipment saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Shanghai Taisheng Wind Power Equipment is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Shanghai Taisheng Wind Power Equipment's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Be aware that Shanghai Taisheng Wind Power Equipment is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.