Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Zhejiang Sunflower Great Health Co., Ltd. (SZSE:300111) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Zhejiang Sunflower Great Health Carry?

The image below, which you can click on for greater detail, shows that Zhejiang Sunflower Great Health had debt of CN¥42.0m at the end of June 2024, a reduction from CN¥98.4m over a year. But it also has CN¥655.1m in cash to offset that, meaning it has CN¥613.0m net cash.

How Strong Is Zhejiang Sunflower Great Health's Balance Sheet?

According to the last reported balance sheet, Zhejiang Sunflower Great Health had liabilities of CN¥152.1m due within 12 months, and liabilities of CN¥37.2m due beyond 12 months. On the other hand, it had cash of CN¥655.1m and CN¥46.1m worth of receivables due within a year. So it actually has CN¥511.9m more liquid assets than total liabilities.

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

Although Zhejiang Sunflower Great Health made a loss at the EBIT level, last year, it was also good to see that it generated CN¥26m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Zhejiang Sunflower Great Health will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Zhejiang Sunflower Great Health 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. Over the last year, Zhejiang Sunflower Great Health actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Sunflower Great Health has CN¥613.0m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 1,427% of that EBIT to free cash flow, bringing in CN¥367m. So is Zhejiang Sunflower Great Health's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 1 warning sign for Zhejiang Sunflower Great Health 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.