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. Importantly, Hexing Electrical Co.,Ltd. (SHSE:603556) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Hexing ElectricalLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Hexing ElectricalLtd had CN¥428.4m of debt in March 2024, down from CN¥537.0m, one year before. However, it does have CN¥4.66b in cash offsetting this, leading to net cash of CN¥4.24b.

How Strong Is Hexing ElectricalLtd's Balance Sheet?

According to the last reported balance sheet, Hexing ElectricalLtd had liabilities of CN¥2.02b due within 12 months, and liabilities of CN¥286.8m due beyond 12 months. On the other hand, it had cash of CN¥4.66b and CN¥1.24b worth of receivables due within a year. So it can boast CN¥3.59b more liquid assets than total liabilities.

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

On top of that, Hexing ElectricalLtd grew its EBIT by 56% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hexing ElectricalLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hexing ElectricalLtd 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. Over the last three years, Hexing ElectricalLtd recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hexing ElectricalLtd has CN¥4.24b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥1.2b, being 91% of its EBIT. So we don't think Hexing ElectricalLtd's use of debt is risky. 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 example - Hexing ElectricalLtd has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com