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.' 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. As with many other companies Sinomach Auto mobile Co.,Ltd (SHSE:600335) makes use of 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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

What Is Sinomach Auto mobileLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Sinomach Auto mobileLtd had CN¥2.64b of debt in March 2024, down from CN¥3.21b, one year before. But it also has CN¥3.17b in cash to offset that, meaning it has CN¥526.4m net cash.

How Healthy Is Sinomach Auto mobileLtd's Balance Sheet?

According to the last reported balance sheet, Sinomach Auto mobileLtd had liabilities of CN¥19.9b due within 12 months, and liabilities of CN¥1.11b due beyond 12 months. On the other hand, it had cash of CN¥3.17b and CN¥12.0b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.81b.

This deficit isn't so bad because Sinomach Auto mobileLtd is worth CN¥10.5b, 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, Sinomach Auto mobileLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Sinomach Auto mobileLtd has boosted its EBIT by 53%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sinomach Auto mobileLtd'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sinomach Auto mobileLtd 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. Over the last three years, Sinomach Auto mobileLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

Although Sinomach Auto mobileLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥526.4m. And it impressed us with its EBIT growth of 53% over the last year. So we are not troubled with Sinomach Auto mobileLtd's debt use. 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. We've identified 4 warning signs with Sinomach Auto mobileLtd (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.