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. As with many other companies Anhui Xinke New Materials Co.,Ltd (SHSE:600255) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Anhui Xinke New MaterialsLtd Carry?

As you can see below, Anhui Xinke New MaterialsLtd had CN¥683.7m of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥785.4m in cash, so it actually has CN¥101.7m net cash.

How Strong Is Anhui Xinke New MaterialsLtd's Balance Sheet?

According to the last reported balance sheet, Anhui Xinke New MaterialsLtd had liabilities of CN¥2.01b due within 12 months, and liabilities of CN¥244.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥785.4m as well as receivables valued at CN¥551.7m due within 12 months. So its liabilities total CN¥917.6m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Anhui Xinke New MaterialsLtd has a market capitalization of CN¥4.01b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Anhui Xinke New MaterialsLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Notably, Anhui Xinke New MaterialsLtd made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥66m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Anhui Xinke New MaterialsLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Anhui Xinke New MaterialsLtd 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 year, Anhui Xinke New MaterialsLtd produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Anhui Xinke New MaterialsLtd'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¥101.7m. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in CN¥52m. So we don't have any problem with Anhui Xinke New MaterialsLtd'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. To that end, you should be aware of the 1 warning sign we've spotted with Anhui Xinke New MaterialsLtd .

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.