Is Allied Machinery (SHSE:605060) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Allied Machinery Co., Ltd. (SHSE:605060) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Allied Machinery

How Much Debt Does Allied Machinery Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Allied Machinery had debt of CN¥191.1m, up from CN¥10.0m in one year. However, its balance sheet shows it holds CN¥712.1m in cash, so it actually has CN¥521.0m net cash.

How Healthy Is Allied Machinery's Balance Sheet?

We can see from the most recent balance sheet that Allied Machinery had liabilities of CN¥424.3m falling due within a year, and liabilities of CN¥59.6m due beyond that. On the other hand, it had cash of CN¥712.1m and CN¥400.9m worth of receivables due within a year. So it can boast CN¥629.1m more liquid assets than total liabilities.

This surplus suggests that Allied Machinery has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Allied Machinery has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Allied Machinery's load is not too heavy, because its EBIT was down 26% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Allied Machinery 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Allied 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. Considering the last three years, Allied Machinery actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Allied Machinery has CN¥521.0m in net cash and a decent-looking balance sheet. So we don't have any problem with Allied Machinery's use of debt. 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. For instance, we've identified 1 warning sign for Allied Machinery that you should be aware of.

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.

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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.