Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 National Electric Apparatus Research Institute Co., Ltd. (SHSE:688128) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for China National Electric Apparatus Research Institute

What Is China National Electric Apparatus Research Institute's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2023 China National Electric Apparatus Research Institute had debt of CN¥46.3m, up from CN¥25.5m in one year. But it also has CN¥764.7m in cash to offset that, meaning it has CN¥718.4m net cash.

How Healthy Is China National Electric Apparatus Research Institute's Balance Sheet?

According to the last reported balance sheet, China National Electric Apparatus Research Institute had liabilities of CN¥3.47b due within 12 months, and liabilities of CN¥232.3m due beyond 12 months. Offsetting these obligations, it had cash of CN¥764.7m as well as receivables valued at CN¥1.73b due within 12 months. So its liabilities total CN¥1.20b more than the combination of its cash and short-term receivables.

Of course, China National Electric Apparatus Research Institute has a market capitalization of CN¥9.97b, 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, China National Electric Apparatus Research Institute boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that China National Electric Apparatus Research Institute has boosted its EBIT by 58%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China National Electric Apparatus Research Institute will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. China National Electric Apparatus Research Institute 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. Over the most recent three years, China National Electric Apparatus Research Institute recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While China National Electric Apparatus Research Institute does have more liabilities than liquid assets, it also has net cash of CN¥718.4m. And we liked the look of last year's 58% year-on-year EBIT growth. So is China National Electric Apparatus Research Institute's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for China National Electric Apparatus Research Institute that you should be aware of before investing here.

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.