David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Suzhou Hengmingda Electronic Technology Co., Ltd. (SZSE:002947) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Suzhou Hengmingda Electronic Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Suzhou Hengmingda Electronic Technology had debt of CN¥27.0m, up from none in one year. But it also has CN¥573.4m in cash to offset that, meaning it has CN¥546.4m net cash.

How Healthy Is Suzhou Hengmingda Electronic Technology's Balance Sheet?

According to the last reported balance sheet, Suzhou Hengmingda Electronic Technology had liabilities of CN¥672.5m due within 12 months, and liabilities of CN¥118.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥573.4m as well as receivables valued at CN¥700.8m due within 12 months. So it can boast CN¥483.8m more liquid assets than total liabilities.

This surplus suggests that Suzhou Hengmingda Electronic Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Suzhou Hengmingda Electronic Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Suzhou Hengmingda Electronic Technology has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Suzhou Hengmingda Electronic Technology'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Suzhou Hengmingda Electronic Technology 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. Over the last three years, Suzhou Hengmingda 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 Suzhou Hengmingda Electronic Technology has net cash of CN¥546.4m, as well as more liquid assets than liabilities. And we liked the look of last year's 23% year-on-year EBIT growth. So we are not troubled with Suzhou Hengmingda Electronic Technology's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Suzhou Hengmingda Electronic Technology you should be aware of.

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.