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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Zhejiang Jingsheng Mechanical & Electrical Co., Ltd. (SZSE:300316) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Jingsheng Mechanical & Electrical's Net Debt?

As you can see below, at the end of March 2024, Zhejiang Jingsheng Mechanical & Electrical had CN¥1.82b of debt, up from CN¥1.09b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥3.42b in cash, so it actually has CN¥1.60b net cash.

A Look At Zhejiang Jingsheng Mechanical & Electrical's Liabilities

According to the last reported balance sheet, Zhejiang Jingsheng Mechanical & Electrical had liabilities of CN¥18.0b due within 12 months, and liabilities of CN¥1.21b due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.42b as well as receivables valued at CN¥5.94b due within 12 months. So its liabilities total CN¥9.83b more than the combination of its cash and short-term receivables.

Zhejiang Jingsheng Mechanical & Electrical has a market capitalization of CN¥44.3b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Zhejiang Jingsheng Mechanical & Electrical also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Zhejiang Jingsheng Mechanical & Electrical grew its EBIT by 62% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Zhejiang Jingsheng Mechanical & Electrical can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Zhejiang Jingsheng Mechanical & Electrical 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, Zhejiang Jingsheng Mechanical & Electrical barely recorded positive free cash flow, in total. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Summing Up

While Zhejiang Jingsheng Mechanical & Electrical does have more liabilities than liquid assets, it also has net cash of CN¥1.60b. And it impressed us with its EBIT growth of 62% over the last year. So we are not troubled with Zhejiang Jingsheng Mechanical & Electrical's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Zhejiang Jingsheng Mechanical & Electrical (1 is a bit concerning) you should be aware of.

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.