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. As with many other companies Hwatsing Technology Co., Ltd. (SHSE:688120) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Hwatsing Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that Hwatsing Technology had CN¥583.4m of debt in June 2024, down from CN¥679.1m, one year before. However, its balance sheet shows it holds CN¥4.47b in cash, so it actually has CN¥3.89b net cash.

How Healthy Is Hwatsing Technology's Balance Sheet?

We can see from the most recent balance sheet that Hwatsing Technology had liabilities of CN¥3.41b falling due within a year, and liabilities of CN¥1.00b due beyond that. Offsetting these obligations, it had cash of CN¥4.47b as well as receivables valued at CN¥755.0m due within 12 months. So it actually has CN¥813.8m more liquid assets than total liabilities.

This surplus suggests that Hwatsing Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Hwatsing Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Hwatsing Technology grew its EBIT at 11% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hwatsing Technology can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Hwatsing Technology 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. In the last three years, Hwatsing Technology's free cash flow amounted to 32% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hwatsing Technology has net cash of CN¥3.89b, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 11% in the last twelve months. So we don't have any problem with Hwatsing Technology's use of debt. 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. We've identified 1 warning sign with Hwatsing Technology , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.