Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Shandong Kaisheng New Materials Co.,Ltd. (SZSE:301069) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 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 Shandong Kaisheng New MaterialsLtd's Debt?

As you can see below, at the end of March 2024, Shandong Kaisheng New MaterialsLtd had CN¥489.9m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has CN¥974.0m in cash, leading to a CN¥484.1m net cash position.

How Healthy Is Shandong Kaisheng New MaterialsLtd's Balance Sheet?

The latest balance sheet data shows that Shandong Kaisheng New MaterialsLtd had liabilities of CN¥264.3m due within a year, and liabilities of CN¥493.2m falling due after that. On the other hand, it had cash of CN¥974.0m and CN¥251.0m worth of receivables due within a year. So it actually has CN¥467.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Shandong Kaisheng New MaterialsLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Shandong Kaisheng New MaterialsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Shandong Kaisheng New MaterialsLtd's saving grace is its low debt levels, because its EBIT has tanked 37% in the last twelve months. 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 it is Shandong Kaisheng New MaterialsLtd's earnings that will influence how the balance sheet holds up in the future. 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. Shandong Kaisheng New MaterialsLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Shandong Kaisheng New MaterialsLtd recorded negative free cash flow, in total. 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 Shandong Kaisheng New MaterialsLtd has CN¥484.1m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Shandong Kaisheng New MaterialsLtd's balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Shandong Kaisheng New MaterialsLtd you should know about.

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