Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Centre Testing International Group Co. Ltd. (SZSE:300012) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Centre Testing International Group's Net Debt?

The image below, which you can click on for greater detail, shows that Centre Testing International Group had debt of CN¥124.3m at the end of March 2024, a reduction from CN¥157.5m over a year. However, it does have CN¥1.08b in cash offsetting this, leading to net cash of CN¥955.2m.

A Look At Centre Testing International Group's Liabilities

The latest balance sheet data shows that Centre Testing International Group had liabilities of CN¥1.38b due within a year, and liabilities of CN¥494.0m falling due after that. Offsetting this, it had CN¥1.08b in cash and CN¥1.94b in receivables that were due within 12 months. So it can boast CN¥1.15b more liquid assets than total liabilities.

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

On the other hand, Centre Testing International Group's EBIT dived 13%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Centre Testing International Group's ability to maintain a healthy balance sheet going forward. 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. While Centre Testing International Group 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. During the last three years, Centre Testing International Group produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Centre Testing International Group has net cash of CN¥955.2m, as well as more liquid assets than liabilities. So we don't have any problem with Centre Testing International Group's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Centre Testing International Group, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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