Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Sinoma International Engineering Co.,Ltd (SHSE:600970) does carry debt. 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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Sinoma International EngineeringLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Sinoma International EngineeringLtd had CN¥6.17b of debt in September 2024, down from CN¥7.38b, one year before. However, it does have CN¥6.34b in cash offsetting this, leading to net cash of CN¥164.8m.

A Look At Sinoma International EngineeringLtd's Liabilities

We can see from the most recent balance sheet that Sinoma International EngineeringLtd had liabilities of CN¥29.4b falling due within a year, and liabilities of CN¥4.62b due beyond that. Offsetting these obligations, it had cash of CN¥6.34b as well as receivables valued at CN¥22.6b due within 12 months. So it has liabilities totalling CN¥5.14b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Sinoma International EngineeringLtd is worth CN¥25.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Sinoma International EngineeringLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also good is that Sinoma International EngineeringLtd grew its EBIT at 14% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sinoma International EngineeringLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sinoma International EngineeringLtd 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. In the last three years, Sinoma International EngineeringLtd's free cash flow amounted to 42% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While Sinoma International EngineeringLtd does have more liabilities than liquid assets, it also has net cash of CN¥164.8m. And it also grew its EBIT by 14% over the last year. So we don't have any problem with Sinoma International EngineeringLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Sinoma International EngineeringLtd is showing 1 warning sign in our investment analysis , you should know about...

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.