Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Jiangsu Zeyu Intelligent Power Co.,Ltd. (SZSE:301179) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Jiangsu Zeyu Intelligent PowerLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Jiangsu Zeyu Intelligent PowerLtd had CN¥340.1m of debt, an increase on CN¥320.2m, over one year. However, its balance sheet shows it holds CN¥2.24b in cash, so it actually has CN¥1.90b net cash.

How Strong Is Jiangsu Zeyu Intelligent PowerLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jiangsu Zeyu Intelligent PowerLtd had liabilities of CN¥795.6m due within 12 months and liabilities of CN¥1.45m due beyond that. On the other hand, it had cash of CN¥2.24b and CN¥286.9m worth of receivables due within a year. So it actually has CN¥1.73b more liquid assets than total liabilities.

It's good to see that Jiangsu Zeyu Intelligent PowerLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Jiangsu Zeyu Intelligent PowerLtd 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 Jiangsu Zeyu Intelligent PowerLtd if management cannot prevent a repeat of the 20% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Jiangsu Zeyu Intelligent PowerLtd'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. Jiangsu Zeyu Intelligent PowerLtd 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. Looking at the most recent three years, Jiangsu Zeyu Intelligent PowerLtd recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Jiangsu Zeyu Intelligent PowerLtd has CN¥1.90b in net cash and a decent-looking balance sheet. So we don't have any problem with Jiangsu Zeyu Intelligent PowerLtd's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Jiangsu Zeyu Intelligent PowerLtd is showing 2 warning signs in our investment analysis , and 1 of those is significant...

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.