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. We note that Qingdao Zhongzi Zhongcheng Group Co.,Ltd. (SZSE:300208) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Qingdao Zhongzi Zhongcheng GroupLtd

What Is Qingdao Zhongzi Zhongcheng GroupLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Qingdao Zhongzi Zhongcheng GroupLtd had CN¥479.7m of debt in September 2023, down from CN¥2.04b, one year before. However, it does have CN¥183.1m in cash offsetting this, leading to net debt of about CN¥296.6m.

A Look At Qingdao Zhongzi Zhongcheng GroupLtd's Liabilities

The latest balance sheet data shows that Qingdao Zhongzi Zhongcheng GroupLtd had liabilities of CN¥3.96b due within a year, and liabilities of CN¥60.6m falling due after that. Offsetting this, it had CN¥183.1m in cash and CN¥3.00b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥836.8m.

Since publicly traded Qingdao Zhongzi Zhongcheng GroupLtd shares are worth a total of CN¥4.38b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 1.3 and interest cover of 7.0 times, it seems to us that Qingdao Zhongzi Zhongcheng GroupLtd is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. It was also good to see that despite losing money on the EBIT line last year, Qingdao Zhongzi Zhongcheng GroupLtd turned things around in the last 12 months, delivering and EBIT of CN¥209m. 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 Qingdao Zhongzi Zhongcheng GroupLtd 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Qingdao Zhongzi Zhongcheng GroupLtd saw substantial negative free cash flow, in total. 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

Qingdao Zhongzi Zhongcheng GroupLtd's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability to handle its debt, based on its EBITDA, isn't too shabby at all. We think that Qingdao Zhongzi Zhongcheng GroupLtd's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Qingdao Zhongzi Zhongcheng GroupLtd that you should be aware of.

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.