Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Nanjing Hanrui Cobalt Co.,Ltd. (SZSE:300618) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Nanjing Hanrui CobaltLtd

What Is Nanjing Hanrui CobaltLtd's Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Nanjing Hanrui CobaltLtd had debt of CN¥2.47b, up from CN¥851.3m in one year. However, because it has a cash reserve of CN¥2.33b, its net debt is less, at about CN¥137.6m.

How Healthy Is Nanjing Hanrui CobaltLtd's Balance Sheet?

We can see from the most recent balance sheet that Nanjing Hanrui CobaltLtd had liabilities of CN¥3.50b falling due within a year, and liabilities of CN¥367.4m due beyond that. Offsetting this, it had CN¥2.33b in cash and CN¥1.10b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥435.0m.

Since publicly traded Nanjing Hanrui CobaltLtd shares are worth a total of CN¥17.8b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, Nanjing Hanrui CobaltLtd has a very light debt load indeed.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Nanjing Hanrui CobaltLtd has a low net debt to EBITDA ratio of only 0.12. And its EBIT covers its interest expense a whopping 1k times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Nanjing Hanrui CobaltLtd has boosted its EBIT by 98%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Nanjing Hanrui CobaltLtd will need earnings to service that debt. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Nanjing Hanrui CobaltLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Happily, Nanjing Hanrui CobaltLtd's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. When we consider the range of factors above, it looks like Nanjing Hanrui CobaltLtd is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. Case in point: We've spotted 2 warning signs for Nanjing Hanrui CobaltLtd you should be aware of, and 1 of them shouldn't be ignored.

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.