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 China Railway Hi-tech Industry Corporation Limited (SHSE:600528) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for China Railway Hi-tech Industry

What Is China Railway Hi-tech Industry's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 China Railway Hi-tech Industry had debt of CN¥598.0m, up from CN¥385.0m in one year. However, its balance sheet shows it holds CN¥4.98b in cash, so it actually has CN¥4.38b net cash.

A Look At China Railway Hi-tech Industry's Liabilities

The latest balance sheet data shows that China Railway Hi-tech Industry had liabilities of CN¥26.9b due within a year, and liabilities of CN¥820.0m falling due after that. Offsetting these obligations, it had cash of CN¥4.98b as well as receivables valued at CN¥13.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥9.14b.

While this might seem like a lot, it is not so bad since China Railway Hi-tech Industry has a market capitalization of CN¥16.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, China Railway Hi-tech Industry also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that China Railway Hi-tech Industry saw its EBIT decline by 4.8% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is China Railway Hi-tech Industry's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. China Railway Hi-tech Industry 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, China Railway Hi-tech Industry 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

Although China Railway Hi-tech Industry's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥4.38b. So although we see some areas for improvement, we're not too worried about China Railway Hi-tech Industry's balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for China Railway Hi-tech Industry 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.