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 Jiangsu Tongrun Equipment Technology Co.,Ltd (SZSE:002150) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

How Much Debt Does Jiangsu Tongrun Equipment TechnologyLtd Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Jiangsu Tongrun Equipment TechnologyLtd had debt of CN¥347.2m, up from CN¥21.0m in one year. However, its balance sheet shows it holds CN¥922.5m in cash, so it actually has CN¥575.4m net cash.

How Healthy Is Jiangsu Tongrun Equipment TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Jiangsu Tongrun Equipment TechnologyLtd had liabilities of CN¥1.91b due within 12 months, and liabilities of CN¥165.4m due beyond 12 months. On the other hand, it had cash of CN¥922.5m and CN¥812.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥341.1m.

Given Jiangsu Tongrun Equipment TechnologyLtd has a market capitalization of CN¥5.68b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Jiangsu Tongrun Equipment TechnologyLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Jiangsu Tongrun Equipment TechnologyLtd's saving grace is its low debt levels, because its EBIT has tanked 46% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Jiangsu Tongrun Equipment TechnologyLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Jiangsu Tongrun Equipment TechnologyLtd 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. Looking at the most recent three years, Jiangsu Tongrun Equipment TechnologyLtd recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Jiangsu Tongrun Equipment TechnologyLtd has CN¥575.4m in net cash. So we are not troubled with Jiangsu Tongrun Equipment TechnologyLtd's debt use. 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 Jiangsu Tongrun Equipment TechnologyLtd has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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.