David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Hanyu Group Joint-Stock Co., Ltd. (SZSE:300403) does use debt in its business. 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Hanyu Group's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Hanyu Group had debt of CN¥58.0m, up from CN¥21.1m in one year. However, its balance sheet shows it holds CN¥58.4m in cash, so it actually has CN¥354.3k net cash.

A Look At Hanyu Group's Liabilities

According to the last reported balance sheet, Hanyu Group had liabilities of CN¥427.6m due within 12 months, and liabilities of CN¥18.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥58.4m as well as receivables valued at CN¥479.2m due within 12 months. So it can boast CN¥91.4m more liquid assets than total liabilities.

This state of affairs indicates that Hanyu Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥5.95b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Hanyu Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Hanyu Group's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hanyu Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Hanyu Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Hanyu Group recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hanyu Group has net cash of CN¥354.3k, as well as more liquid assets than liabilities. The cherry on top was that in converted 75% of that EBIT to free cash flow, bringing in CN¥149m. So is Hanyu Group's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Hanyu Group (1 makes us a bit uncomfortable) you should be aware of.

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.