David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Honor Electronic Co., Ltd. (SZSE:300870) makes use of debt. But is this debt a concern to shareholders?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Shenzhen Honor Electronic Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Shenzhen Honor Electronic had debt of CN¥1.11b, up from CN¥575.9m in one year. But it also has CN¥1.39b in cash to offset that, meaning it has CN¥277.0m net cash.

How Strong Is Shenzhen Honor Electronic's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen Honor Electronic had liabilities of CN¥2.20b due within 12 months and liabilities of CN¥869.2m due beyond that. Offsetting these obligations, it had cash of CN¥1.39b as well as receivables valued at CN¥1.42b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥253.6m.

Of course, Shenzhen Honor Electronic has a market capitalization of CN¥9.75b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Shenzhen Honor Electronic also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Shenzhen Honor Electronic grew its EBIT by 113% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Shenzhen Honor Electronic 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shenzhen Honor Electronic 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 two years, Shenzhen Honor Electronic'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 it is always sensible to look at a company's total liabilities, it is very reassuring that Shenzhen Honor Electronic has CN¥277.0m in net cash. And we liked the look of last year's 113% year-on-year EBIT growth. So we don't think Shenzhen Honor Electronic'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. For example Shenzhen Honor Electronic has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.