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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Hanyu Group Joint-Stock Co., Ltd. (SZSE:300403) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Hanyu Group's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Hanyu Group had debt of CN¥36.1m, up from CN¥17.6m in one year. However, it does have CN¥183.3m in cash offsetting this, leading to net cash of CN¥147.3m.

How Healthy Is Hanyu Group's Balance Sheet?

The latest balance sheet data shows that Hanyu Group had liabilities of CN¥389.8m due within a year, and liabilities of CN¥17.8m falling due after that. On the other hand, it had cash of CN¥183.3m and CN¥453.3m worth of receivables due within a year. So it actually has CN¥229.0m more liquid assets than total liabilities.

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

Also positive, Hanyu Group grew its EBIT by 30% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hanyu Group 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Hanyu Group 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. During the last three years, Hanyu Group produced sturdy free cash flow equating to 54% 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 Hanyu Group has net cash of CN¥147.3m, as well as more liquid assets than liabilities. And we liked the look of last year's 30% year-on-year EBIT growth. So is Hanyu Group's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 1 warning sign for Hanyu Group that you should be aware of.

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.