Warren Buffett famously said, '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. As with many other companies AviChina Industry & Technology Company Limited (HKG:2357) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for AviChina Industry & Technology

What Is AviChina Industry & Technology's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 AviChina Industry & Technology had debt of CN¥12.5b, up from CN¥7.25b in one year. However, it does have CN¥17.3b in cash offsetting this, leading to net cash of CN¥4.86b.

How Strong Is AviChina Industry & Technology's Balance Sheet?

The latest balance sheet data shows that AviChina Industry & Technology had liabilities of CN¥69.7b due within a year, and liabilities of CN¥8.54b falling due after that. Offsetting these obligations, it had cash of CN¥17.3b as well as receivables valued at CN¥43.2b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥17.7b.

This deficit is considerable relative to its market capitalization of CN¥24.0b, so it does suggest shareholders should keep an eye on AviChina Industry & Technology's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, AviChina Industry & Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that AviChina Industry & Technology has increased its EBIT by 3.4% over twelve months, which should ease any concerns about debt repayment. 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 AviChina Industry & 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. AviChina Industry & Technology 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. Considering the last three years, AviChina Industry & Technology actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While AviChina Industry & Technology does have more liabilities than liquid assets, it also has net cash of CN¥4.86b. On top of that, it increased its EBIT by 3.4% in the last twelve months. So although we see some areas for improvement, we're not too worried about AviChina Industry & Technology's balance sheet. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of AviChina Industry & Technology's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.