Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Shanghai Hi-Tech Control System Co., Ltd (SZSE:002184) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Shanghai Hi-Tech Control System's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Shanghai Hi-Tech Control System had debt of CN¥415.0m, up from CN¥227.7m in one year. But on the other hand it also has CN¥538.4m in cash, leading to a CN¥123.4m net cash position.

How Strong Is Shanghai Hi-Tech Control System's Balance Sheet?

According to the last reported balance sheet, Shanghai Hi-Tech Control System had liabilities of CN¥2.02b due within 12 months, and liabilities of CN¥104.9m due beyond 12 months. Offsetting these obligations, it had cash of CN¥538.4m as well as receivables valued at CN¥1.52b due within 12 months. So it has liabilities totalling CN¥70.7m more than its cash and near-term receivables, combined.

Having regard to Shanghai Hi-Tech Control System's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥4.11b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Shanghai Hi-Tech Control System also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Shanghai Hi-Tech Control System's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Shanghai Hi-Tech Control System made a loss at the EBIT level, and saw its revenue drop to CN¥2.7b, which is a fall of 21%. That makes us nervous, to say the least.

So How Risky Is Shanghai Hi-Tech Control System?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Shanghai Hi-Tech Control System had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through CN¥123m of cash and made a loss of CN¥91m. Given it only has net cash of CN¥123.4m, the company may need to raise more capital if it doesn't reach break-even soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Shanghai Hi-Tech Control System 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.