Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Shenzhen JPT Opto-Electronics Co., Ltd. (SHSE:688025) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shenzhen JPT Opto-Electronics

How Much Debt Does Shenzhen JPT Opto-Electronics Carry?

The image below, which you can click on for greater detail, shows that at June 2022 Shenzhen JPT Opto-Electronics had debt of CN¥144.1m, up from CN¥30.0m in one year. However, its balance sheet shows it holds CN¥500.5m in cash, so it actually has CN¥356.5m net cash.

How Strong Is Shenzhen JPT Opto-Electronics' Balance Sheet?

We can see from the most recent balance sheet that Shenzhen JPT Opto-Electronics had liabilities of CN¥608.0m falling due within a year, and liabilities of CN¥111.2m due beyond that. Offsetting this, it had CN¥500.5m in cash and CN¥441.9m in receivables that were due within 12 months. So it actually has CN¥223.3m more liquid assets than total liabilities.

This surplus suggests that Shenzhen JPT Opto-Electronics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shenzhen JPT Opto-Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Shenzhen JPT Opto-Electronics grew its EBIT by 9.4% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shenzhen JPT Opto-Electronics'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Shenzhen JPT Opto-Electronics 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 JPT Opto-Electronics 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 it is always sensible to investigate a company's debt, in this case Shenzhen JPT Opto-Electronics has CN¥356.5m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 9.4% in the last twelve months. So we are not troubled with Shenzhen JPT Opto-Electronics's debt use. 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. Case in point: We've spotted 3 warning signs for Shenzhen JPT Opto-Electronics you should be aware of, and 1 of them can't be ignored.

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.