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. We note that CETC Acoustic-Optic-Electronic Technology Inc. (SHSE:600877) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for CETC Acoustic-Optic-Electronic Technology

What Is CETC Acoustic-Optic-Electronic Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 CETC Acoustic-Optic-Electronic Technology had CN¥166.2m of debt, an increase on CN¥6.12m, over one year. But it also has CN¥938.7m in cash to offset that, meaning it has CN¥772.4m net cash.

A Look At CETC Acoustic-Optic-Electronic Technology's Liabilities

Zooming in on the latest balance sheet data, we can see that CETC Acoustic-Optic-Electronic Technology had liabilities of CN¥624.5m due within 12 months and liabilities of CN¥21.2m due beyond that. Offsetting this, it had CN¥938.7m in cash and CN¥908.3m in receivables that were due within 12 months. So it can boast CN¥1.20b more liquid assets than total liabilities.

This short term liquidity is a sign that CETC Acoustic-Optic-Electronic Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, CETC Acoustic-Optic-Electronic Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, CETC Acoustic-Optic-Electronic Technology grew its EBIT by 185% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CETC Acoustic-Optic-Electronic Technology 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While CETC Acoustic-Optic-Electronic Technology has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, CETC Acoustic-Optic-Electronic Technology reported free cash flow worth 4.5% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that CETC Acoustic-Optic-Electronic Technology has net cash of CN¥772.4m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 185% over the last year. So is CETC Acoustic-Optic-Electronic Technology's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 4 warning signs for CETC Acoustic-Optic-Electronic Technology you should be aware of, and 1 of them is potentially serious.

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.