Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Wuxi Paike New Materials Technology Co.,Ltd. (SHSE:605123) does carry debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is Wuxi Paike New Materials TechnologyLtd's Debt?

The image below, which you can click on for greater detail, shows that Wuxi Paike New Materials TechnologyLtd had debt of CN¥264.3m at the end of March 2024, a reduction from CN¥460.3m over a year. However, its balance sheet shows it holds CN¥1.70b in cash, so it actually has CN¥1.44b net cash.

How Healthy Is Wuxi Paike New Materials TechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Wuxi Paike New Materials TechnologyLtd had liabilities of CN¥2.15b falling due within a year, and liabilities of CN¥287.2m due beyond that. On the other hand, it had cash of CN¥1.70b and CN¥2.02b worth of receivables due within a year. So it actually has CN¥1.28b more liquid assets than total liabilities.

This excess liquidity suggests that Wuxi Paike New Materials TechnologyLtd is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Wuxi Paike New Materials TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Wuxi Paike New Materials TechnologyLtd if management cannot prevent a repeat of the 21% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Wuxi Paike New Materials TechnologyLtd 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Wuxi Paike New Materials TechnologyLtd 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, Wuxi Paike New Materials TechnologyLtd 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.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Wuxi Paike New Materials TechnologyLtd has net cash of CN¥1.44b, as well as more liquid assets than liabilities. So we are not troubled with Wuxi Paike New Materials TechnologyLtd's debt use. 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 Wuxi Paike New Materials TechnologyLtd that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.