The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 note that Shenzhen Hopewind Electric Co., Ltd. (SHSE:603063) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Shenzhen Hopewind Electric's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Shenzhen Hopewind Electric had CN¥758.4m of debt, an increase on CN¥584.0m, over one year. But on the other hand it also has CN¥1.20b in cash, leading to a CN¥445.3m net cash position.

How Healthy Is Shenzhen Hopewind Electric's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen Hopewind Electric had liabilities of CN¥2.20b due within 12 months and liabilities of CN¥956.5m due beyond that. Offsetting these obligations, it had cash of CN¥1.20b as well as receivables valued at CN¥2.66b due within 12 months. So it can boast CN¥709.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Shenzhen Hopewind Electric could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Shenzhen Hopewind Electric has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Shenzhen Hopewind Electric has boosted its EBIT by 84%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shenzhen Hopewind Electric's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shenzhen Hopewind Electric 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. During the last three years, Shenzhen Hopewind Electric burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Hopewind Electric has net cash of CN¥445.3m, as well as more liquid assets than liabilities. And we liked the look of last year's 84% year-on-year EBIT growth. So we don't have any problem with Shenzhen Hopewind Electric's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Shenzhen Hopewind Electric .

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.