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, Shenzhen Topway Video Communication Co., Ltd (SZSE:002238) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Shenzhen Topway Video Communication Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Shenzhen Topway Video Communication had debt of CN¥484.5m, up from CN¥337.0m in one year. But it also has CN¥1.00b in cash to offset that, meaning it has CN¥518.9m net cash.

A Look At Shenzhen Topway Video Communication's Liabilities

We can see from the most recent balance sheet that Shenzhen Topway Video Communication had liabilities of CN¥1.63b falling due within a year, and liabilities of CN¥273.9m due beyond that. Offsetting these obligations, it had cash of CN¥1.00b as well as receivables valued at CN¥396.5m due within 12 months. So its liabilities total CN¥506.4m more than the combination of its cash and short-term receivables.

Of course, Shenzhen Topway Video Communication has a market capitalization of CN¥8.15b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Shenzhen Topway Video Communication 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 Shenzhen Topway Video Communication if management cannot prevent a repeat of the 26% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shenzhen Topway Video Communication 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shenzhen Topway Video Communication 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. During the last three years, Shenzhen Topway Video Communication produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

We could understand if investors are concerned about Shenzhen Topway Video Communication's liabilities, but we can be reassured by the fact it has has net cash of CN¥518.9m. So we are not troubled with Shenzhen Topway Video Communication's debt use. 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. For example, we've discovered 3 warning signs for Shenzhen Topway Video Communication (1 is a bit concerning!) that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.