Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Sieyuan Electric Co., Ltd. (SZSE:002028) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is Sieyuan Electric's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Sieyuan Electric had debt of CN¥206.8m, up from CN¥91.7m in one year. But it also has CN¥5.12b in cash to offset that, meaning it has CN¥4.91b net cash.

How Healthy Is Sieyuan Electric's Balance Sheet?

We can see from the most recent balance sheet that Sieyuan Electric had liabilities of CN¥9.41b falling due within a year, and liabilities of CN¥185.8m due beyond that. Offsetting this, it had CN¥5.12b in cash and CN¥7.69b in receivables that were due within 12 months. So it can boast CN¥3.22b more liquid assets than total liabilities.

This short term liquidity is a sign that Sieyuan Electric could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Sieyuan Electric boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Sieyuan Electric grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sieyuan Electric 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sieyuan Electric 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 most recent three years, Sieyuan Electric recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sieyuan Electric has CN¥4.91b in net cash and a decent-looking balance sheet. And we liked the look of last year's 25% year-on-year EBIT growth. So we don't think Sieyuan Electric's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Sieyuan Electric you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.