The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Yangzhou Yangjie Electronic Technology Co., Ltd. (SZSE:300373) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Yangzhou Yangjie Electronic Technology's Net Debt?

As you can see below, at the end of September 2023, Yangzhou Yangjie Electronic Technology had CN¥1.40b of debt, up from CN¥683.3m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥3.25b in cash, so it actually has CN¥1.85b net cash.

How Strong Is Yangzhou Yangjie Electronic Technology's Balance Sheet?

According to the last reported balance sheet, Yangzhou Yangjie Electronic Technology had liabilities of CN¥2.68b due within 12 months, and liabilities of CN¥1.34b due beyond 12 months. Offsetting this, it had CN¥3.25b in cash and CN¥2.07b in receivables that were due within 12 months. So it actually has CN¥1.31b more liquid assets than total liabilities.

This short term liquidity is a sign that Yangzhou Yangjie Electronic Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Yangzhou Yangjie Electronic Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Yangzhou Yangjie Electronic Technology if management cannot prevent a repeat of the 42% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Yangzhou Yangjie Electronic 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. While Yangzhou Yangjie Electronic Technology 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, Yangzhou Yangjie Electronic Technology recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Yangzhou Yangjie Electronic Technology has net cash of CN¥1.85b, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Yangzhou Yangjie Electronic Technology's balance sheet. 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. For instance, we've identified 2 warning signs for Yangzhou Yangjie Electronic Technology that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.