Warren Buffett famously said, '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 can see that Victory Giant Technology (HuiZhou)Co.,Ltd. (SZSE:300476) does use debt in its business. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Victory Giant Technology (HuiZhou)Co.Ltd's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Victory Giant Technology (HuiZhou)Co.Ltd had debt of CN¥4.25b, up from CN¥3.96b in one year. However, it does have CN¥1.84b in cash offsetting this, leading to net debt of about CN¥2.41b.

How Strong Is Victory Giant Technology (HuiZhou)Co.Ltd's Balance Sheet?

We can see from the most recent balance sheet that Victory Giant Technology (HuiZhou)Co.Ltd had liabilities of CN¥6.95b falling due within a year, and liabilities of CN¥2.26b due beyond that. Offsetting these obligations, it had cash of CN¥1.84b as well as receivables valued at CN¥3.53b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.84b.

Given Victory Giant Technology (HuiZhou)Co.Ltd has a market capitalization of CN¥23.2b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Victory Giant Technology (HuiZhou)Co.Ltd's net debt is only 1.4 times its EBITDA. And its EBIT covers its interest expense a whopping 18.3 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Victory Giant Technology (HuiZhou)Co.Ltd has boosted its EBIT by 53%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Victory Giant Technology (HuiZhou)Co.Ltd's ability to maintain a healthy balance sheet going forward. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Victory Giant Technology (HuiZhou)Co.Ltd recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Victory Giant Technology (HuiZhou)Co.Ltd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. When we consider the range of factors above, it looks like Victory Giant Technology (HuiZhou)Co.Ltd is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Victory Giant Technology (HuiZhou)Co.Ltd 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.