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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Ningbo Dechang Electrical Machinery Made Co., Ltd. (SHSE:605555) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 Ningbo Dechang Electrical Machinery Made's Debt?

As you can see below, Ningbo Dechang Electrical Machinery Made had CN¥322.3m of debt at March 2024, down from CN¥349.3m a year prior. But on the other hand it also has CN¥1.71b in cash, leading to a CN¥1.39b net cash position.

How Strong Is Ningbo Dechang Electrical Machinery Made's Balance Sheet?

We can see from the most recent balance sheet that Ningbo Dechang Electrical Machinery Made had liabilities of CN¥1.39b falling due within a year, and liabilities of CN¥404.6m due beyond that. On the other hand, it had cash of CN¥1.71b and CN¥986.9m worth of receivables due within a year. So it can boast CN¥904.5m more liquid assets than total liabilities.

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

Better yet, Ningbo Dechang Electrical Machinery Made grew its EBIT by 153% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 Ningbo Dechang Electrical Machinery Made 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Ningbo Dechang Electrical Machinery Made 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. In the last three years, Ningbo Dechang Electrical Machinery Made created free cash flow amounting to 8.3% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Ningbo Dechang Electrical Machinery Made has CN¥1.39b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 153% over the last year. So is Ningbo Dechang Electrical Machinery Made's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Ningbo Dechang Electrical Machinery Made has 1 warning sign we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.