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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Precision Tsugami (China) Corporation Limited (HKG:1651) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Precision Tsugami (China)

How Much Debt Does Precision Tsugami (China) Carry?

The image below, which you can click on for greater detail, shows that at March 2022 Precision Tsugami (China) had debt of CN¥22.1m, up from none in one year. However, its balance sheet shows it holds CN¥555.4m in cash, so it actually has CN¥533.3m net cash.

How Strong Is Precision Tsugami (China)'s Balance Sheet?

The latest balance sheet data shows that Precision Tsugami (China) had liabilities of CN¥1.21b due within a year, and liabilities of CN¥79.0m falling due after that. Offsetting these obligations, it had cash of CN¥555.4m as well as receivables valued at CN¥1.22b due within 12 months. So it actually has CN¥484.7m more liquid assets than total liabilities.

This surplus suggests that Precision Tsugami (China) is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Precision Tsugami (China) boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Precision Tsugami (China) has boosted its EBIT by 68%, thus reducing the spectre of future debt repayments. 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 Precision Tsugami (China) 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, a company can only pay off debt with cold hard cash, not accounting profits. While Precision Tsugami (China) 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. Looking at the most recent three years, Precision Tsugami (China) recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Precision Tsugami (China) has net cash of CN¥533.3m, as well as more liquid assets than liabilities. And we liked the look of last year's 68% year-on-year EBIT growth. So is Precision Tsugami (China)'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. For instance, we've identified 2 warning signs for Precision Tsugami (China) (1 makes us a bit uncomfortable) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.