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.' 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. Importantly, Shenzhen Kedali Industry Co., Ltd. (SZSE:002850) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Shenzhen Kedali Industry's Net Debt?

The chart below, which you can click on for greater detail, shows that Shenzhen Kedali Industry had CN¥2.76b in debt in September 2023; about the same as the year before. But it also has CN¥3.25b in cash to offset that, meaning it has CN¥495.6m net cash.

How Strong Is Shenzhen Kedali Industry's Balance Sheet?

We can see from the most recent balance sheet that Shenzhen Kedali Industry had liabilities of CN¥5.34b falling due within a year, and liabilities of CN¥1.84b due beyond that. Offsetting these obligations, it had cash of CN¥3.25b as well as receivables valued at CN¥5.26b due within 12 months. So it actually has CN¥1.33b more liquid assets than total liabilities.

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

On top of that, Shenzhen Kedali Industry grew its EBIT by 49% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Shenzhen Kedali Industry can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Shenzhen Kedali Industry 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. Over the last three years, Shenzhen Kedali Industry saw substantial negative free cash flow, in total. 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 Kedali Industry has CN¥495.6m in net cash and a decent-looking balance sheet. And we liked the look of last year's 49% year-on-year EBIT growth. So we don't have any problem with Shenzhen Kedali Industry's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shenzhen Kedali Industry (of which 1 is a bit unpleasant!) you should know about.

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.