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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Shenzhen Gongjin Electronics Co., Ltd. (SHSE:603118) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.

What Is Shenzhen Gongjin Electronics's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shenzhen Gongjin Electronics had CN¥1.48b of debt in March 2024, down from CN¥1.94b, one year before. However, its balance sheet shows it holds CN¥1.99b in cash, so it actually has CN¥516.2m net cash.

How Strong Is Shenzhen Gongjin Electronics' Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Gongjin Electronics had liabilities of CN¥4.22b falling due within a year, and liabilities of CN¥364.9m due beyond that. Offsetting these obligations, it had cash of CN¥1.99b as well as receivables valued at CN¥2.10b due within 12 months. So its liabilities total CN¥493.8m more than the combination of its cash and short-term receivables.

Of course, Shenzhen Gongjin Electronics has a market capitalization of CN¥6.26b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Shenzhen Gongjin Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Shenzhen Gongjin Electronics if management cannot prevent a repeat of the 64% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shenzhen Gongjin Electronics can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shenzhen Gongjin Electronics 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, Shenzhen Gongjin Electronics barely recorded positive free cash flow, in total. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Shenzhen Gongjin Electronics has CN¥516.2m in net cash. So while Shenzhen Gongjin Electronics does not have a great balance sheet, it's certainly not too bad. 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. For example, we've discovered 1 warning sign for Shenzhen Gongjin Electronics that you should be aware of before investing here.

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.