Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Zhejiang Jiemei Electronic And Technology Co., Ltd. (SZSE:002859) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

What Is Zhejiang Jiemei Electronic And Technology's Debt?

The image below, which you can click on for greater detail, shows that Zhejiang Jiemei Electronic And Technology had debt of CN¥1.53b at the end of September 2023, a reduction from CN¥1.67b over a year. However, it does have CN¥691.7m in cash offsetting this, leading to net debt of about CN¥838.2m.

A Look At Zhejiang Jiemei Electronic And Technology's Liabilities

The latest balance sheet data shows that Zhejiang Jiemei Electronic And Technology had liabilities of CN¥643.8m due within a year, and liabilities of CN¥1.29b falling due after that. Offsetting these obligations, it had cash of CN¥691.7m as well as receivables valued at CN¥512.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥725.7m.

Of course, Zhejiang Jiemei Electronic And Technology has a market capitalization of CN¥10.2b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Zhejiang Jiemei Electronic And Technology has a debt to EBITDA ratio of 2.6, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 20.7 is very high, suggesting that the interest expense on the debt is currently quite low. Unfortunately, Zhejiang Jiemei Electronic And Technology saw its EBIT slide 2.9% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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 Zhejiang Jiemei Electronic And Technology can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Zhejiang Jiemei Electronic And Technology 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.

Our View

Zhejiang Jiemei Electronic And Technology's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. We think that Zhejiang Jiemei Electronic And Technology's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. Over time, share prices tend to follow earnings per share, so if you're interested in Zhejiang Jiemei Electronic And Technology, you may well want to click here to check an interactive graph of its earnings per share history.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.