Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that World Precision Machinery Limited (SGX:B49) does use debt in its business. But is this debt a concern to shareholders?

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Why Does Debt Bring Risk?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does World Precision Machinery Carry?

The image below, which you can click on for greater detail, shows that World Precision Machinery had debt of CN¥240.0m at the end of December 2024, a reduction from CN¥250.0m over a year. However, it does have CN¥264.9m in cash offsetting this, leading to net cash of CN¥24.9m.

How Strong Is World Precision Machinery's Balance Sheet?

We can see from the most recent balance sheet that World Precision Machinery had liabilities of CN¥1.04b falling due within a year, and liabilities of CN¥44.7m due beyond that. On the other hand, it had cash of CN¥264.9m and CN¥482.7m worth of receivables due within a year. So its liabilities total CN¥333.0m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥401.3m, so it does suggest shareholders should keep an eye on World Precision Machinery's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, World Precision Machinery also has more cash than debt, so we're pretty confident it can manage its debt safely.

See our latest analysis for World Precision Machinery

The modesty of its debt load may become crucial for World Precision Machinery if management cannot prevent a repeat of the 76% 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is World Precision Machinery'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While World Precision Machinery 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. Happily for any shareholders, World Precision Machinery actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although World Precision Machinery's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥24.9m. And it impressed us with free cash flow of -CN¥2.9m, being 219% of its EBIT. So we don't have any problem with World Precision Machinery's use of debt. 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. Case in point: We've spotted 5 warning signs for World Precision Machinery you should be aware of, and 3 of them are significant.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.