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. We can see that Canmax Technologies Co., Ltd. (SZSE:300390) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is Canmax Technologies's Net Debt?

As you can see below, at the end of September 2023, Canmax Technologies had CN¥2.55b of debt, up from CN¥2.13b a year ago. Click the image for more detail. However, it does have CN¥8.28b in cash offsetting this, leading to net cash of CN¥5.73b.

A Look At Canmax Technologies' Liabilities

According to the last reported balance sheet, Canmax Technologies had liabilities of CN¥3.48b due within 12 months, and liabilities of CN¥1.09b due beyond 12 months. Offsetting this, it had CN¥8.28b in cash and CN¥996.8m in receivables that were due within 12 months. So it can boast CN¥4.70b more liquid assets than total liabilities.

It's good to see that Canmax Technologies has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Canmax Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Canmax Technologies's load is not too heavy, because its EBIT was down 50% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Canmax Technologies'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. While Canmax Technologies 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. In the last three years, Canmax Technologies's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Canmax Technologies has CN¥5.73b in net cash and a decent-looking balance sheet. So we don't have any problem with Canmax Technologies's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Canmax Technologies (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.