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 Shenzhen VMAX New Energy Co., Ltd. (SHSE:688612) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Shenzhen VMAX New Energy's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Shenzhen VMAX New Energy had debt of CN¥653.4m, up from CN¥509.9m in one year. However, its balance sheet shows it holds CN¥2.62b in cash, so it actually has CN¥1.96b net cash.

How Strong Is Shenzhen VMAX New Energy's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen VMAX New Energy had liabilities of CN¥3.81b due within 12 months and liabilities of CN¥359.0m due beyond that. Offsetting this, it had CN¥2.62b in cash and CN¥2.21b in receivables that were due within 12 months. So it actually has CN¥655.7m more liquid assets than total liabilities.

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

In addition to that, we're happy to report that Shenzhen VMAX New Energy has boosted its EBIT by 59%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shenzhen VMAX New Energy 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. Shenzhen VMAX New Energy 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 VMAX New Energy reported free cash flow worth 9.6% 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

While it is always sensible to investigate a company's debt, in this case Shenzhen VMAX New Energy has CN¥1.96b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 59% over the last year. So is Shenzhen VMAX New Energy's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Shenzhen VMAX New Energy has 2 warning signs (and 1 which is potentially serious) we think you should know about.

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.

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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.