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 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 can see that Advanced Energy Industries, Inc. (NASDAQ:AEIS) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Advanced Energy Industries's Net Debt?

As you can see below, at the end of March 2024, Advanced Energy Industries had US$911.5m of debt, up from US$368.4m a year ago. Click the image for more detail. But on the other hand it also has US$1.02b in cash, leading to a US$111.7m net cash position.

A Look At Advanced Energy Industries' Liabilities

We can see from the most recent balance sheet that Advanced Energy Industries had liabilities of US$298.0m falling due within a year, and liabilities of US$1.08b due beyond that. On the other hand, it had cash of US$1.02b and US$247.5m worth of receivables due within a year. So it has liabilities totalling US$110.5m more than its cash and near-term receivables, combined.

Of course, Advanced Energy Industries has a market capitalization of US$3.75b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Advanced Energy Industries boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Advanced Energy Industries's saving grace is its low debt levels, because its EBIT has tanked 57% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Advanced Energy Industries's ability to maintain a healthy balance sheet going forward. 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. Advanced Energy Industries 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. During the last three years, Advanced Energy Industries produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Advanced Energy Industries has US$111.7m in net cash. So we are not troubled with Advanced Energy Industries's debt use. 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 - Advanced Energy Industries has 2 warning signs we think you should be aware of.

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.