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 note that Nanjing Xinjiekou Department Store Co., Ltd. (SHSE:600682) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Nanjing Xinjiekou Department Store's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Nanjing Xinjiekou Department Store had CN¥810.1m of debt in March 2024, down from CN¥877.6m, one year before. However, its balance sheet shows it holds CN¥5.73b in cash, so it actually has CN¥4.92b net cash.

How Strong Is Nanjing Xinjiekou Department Store's Balance Sheet?

According to the last reported balance sheet, Nanjing Xinjiekou Department Store had liabilities of CN¥6.09b due within 12 months, and liabilities of CN¥1.03b due beyond 12 months. Offsetting this, it had CN¥5.73b in cash and CN¥1.56b in receivables that were due within 12 months. So it actually has CN¥173.1m more liquid assets than total liabilities.

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

In fact Nanjing Xinjiekou Department Store's saving grace is its low debt levels, because its EBIT has tanked 29% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is Nanjing Xinjiekou Department Store'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. While Nanjing Xinjiekou Department Store 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, Nanjing Xinjiekou Department Store recorded free cash flow worth a fulsome 98% 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 Nanjing Xinjiekou Department Store has CN¥4.92b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥443m, being 98% of its EBIT. So we don't have any problem with Nanjing Xinjiekou Department Store's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Nanjing Xinjiekou Department Store that 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.