The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that Chongqing Mas Sci.&Tech.Co.,Ltd. (SZSE:300275) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Chongqing Mas Sci.&Tech.Co.Ltd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Chongqing Mas Sci.&Tech.Co.Ltd had CN¥159.5m of debt, an increase on CN¥144.9m, over one year. However, it does have CN¥35.4m in cash offsetting this, leading to net debt of about CN¥124.1m.

A Look At Chongqing Mas Sci.&Tech.Co.Ltd's Liabilities

Zooming in on the latest balance sheet data, we can see that Chongqing Mas Sci.&Tech.Co.Ltd had liabilities of CN¥346.1m due within 12 months and liabilities of CN¥116.9m due beyond that. Offsetting this, it had CN¥35.4m in cash and CN¥540.1m in receivables that were due within 12 months. So it actually has CN¥112.5m more liquid assets than total liabilities.

This surplus suggests that Chongqing Mas Sci.&Tech.Co.Ltd has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Chongqing Mas Sci.&Tech.Co.Ltd has a low net debt to EBITDA ratio of only 1.5. And its EBIT easily covers its interest expense, being 97.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Chongqing Mas Sci.&Tech.Co.Ltd grew its EBIT by 62% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Chongqing Mas Sci.&Tech.Co.Ltd 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. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Chongqing Mas Sci.&Tech.Co.Ltd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Chongqing Mas Sci.&Tech.Co.Ltd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Chongqing Mas Sci.&Tech.Co.Ltd can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. To that end, you should be aware of the 1 warning sign we've spotted with Chongqing Mas Sci.&Tech.Co.Ltd .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.