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.' 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. We can see that Wuxi Huadong Heavy Machinery Co., Ltd. (SZSE:002685) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, 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 Wuxi Huadong Heavy Machinery's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Wuxi Huadong Heavy Machinery had CN¥117.7m of debt in September 2024, down from CN¥189.9m, one year before. However, its balance sheet shows it holds CN¥555.4m in cash, so it actually has CN¥437.7m net cash.

How Healthy Is Wuxi Huadong Heavy Machinery's Balance Sheet?

According to the last reported balance sheet, Wuxi Huadong Heavy Machinery had liabilities of CN¥2.04b due within 12 months, and liabilities of CN¥103.6m due beyond 12 months. On the other hand, it had cash of CN¥555.4m and CN¥140.3m worth of receivables due within a year. So its liabilities total CN¥1.45b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Wuxi Huadong Heavy Machinery has a market capitalization of CN¥5.89b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Wuxi Huadong Heavy Machinery boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Wuxi Huadong Heavy Machinery will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Wuxi Huadong Heavy Machinery made a loss at the EBIT level, and saw its revenue drop to CN¥1.1b, which is a fall of 13%. That's not what we would hope to see.

So How Risky Is Wuxi Huadong Heavy Machinery?

While Wuxi Huadong Heavy Machinery lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow CN¥76m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Wuxi Huadong Heavy Machinery that 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.