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.' 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. Importantly, Shenyang Fortune Precision Equipment Co., Ltd. (SHSE:688409) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Shenyang Fortune Precision Equipment Carry?

As you can see below, at the end of September 2023, Shenyang Fortune Precision Equipment had CN¥1.20b of debt, up from CN¥598.2m a year ago. Click the image for more detail. However, it does have CN¥2.50b in cash offsetting this, leading to net cash of CN¥1.30b.

How Strong Is Shenyang Fortune Precision Equipment's Balance Sheet?

According to the last reported balance sheet, Shenyang Fortune Precision Equipment had liabilities of CN¥987.1m due within 12 months, and liabilities of CN¥1.55b due beyond 12 months. On the other hand, it had cash of CN¥2.50b and CN¥832.7m worth of receivables due within a year. So it can boast CN¥797.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Shenyang Fortune Precision Equipment could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Shenyang Fortune Precision Equipment has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Shenyang Fortune Precision Equipment's EBIT dived 11%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Shenyang Fortune Precision Equipment 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 Shenyang Fortune Precision Equipment 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, Shenyang Fortune Precision Equipment 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.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenyang Fortune Precision Equipment has net cash of CN¥1.30b, as well as more liquid assets than liabilities. So we are not troubled with Shenyang Fortune Precision Equipment'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. Be aware that Shenyang Fortune Precision Equipment is showing 2 warning signs in our investment analysis , you should know about...

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.