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. Importantly, Sinotrans Limited (HKG:598) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Sinotrans's Debt?

The image below, which you can click on for greater detail, shows that Sinotrans had debt of CN¥9.72b at the end of September 2024, a reduction from CN¥12.3b over a year. However, its balance sheet shows it holds CN¥12.0b in cash, so it actually has CN¥2.24b net cash.

A Look At Sinotrans' Liabilities

We can see from the most recent balance sheet that Sinotrans had liabilities of CN¥32.1b falling due within a year, and liabilities of CN¥8.46b due beyond that. On the other hand, it had cash of CN¥12.0b and CN¥22.2b worth of receivables due within a year. So its liabilities total CN¥6.44b more than the combination of its cash and short-term receivables.

Of course, Sinotrans has a market capitalization of CN¥34.4b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Sinotrans boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Sinotrans grew its EBIT by 13% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sinotrans'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Sinotrans 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, Sinotrans generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although Sinotrans's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥2.24b. And it impressed us with free cash flow of CN¥2.3b, being 91% of its EBIT. So is Sinotrans's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Sinotrans you should know about.

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.