Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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, Ningbo Fujia Industrial Co., Ltd. (SHSE:603219) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

What Is Ningbo Fujia Industrial's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Ningbo Fujia Industrial had debt of CN¥255.0m, up from CN¥153.1m in one year. But on the other hand it also has CN¥565.1m in cash, leading to a CN¥310.1m net cash position.

How Strong Is Ningbo Fujia Industrial's Balance Sheet?

The latest balance sheet data shows that Ningbo Fujia Industrial had liabilities of CN¥1.35b due within a year, and liabilities of CN¥32.1m falling due after that. On the other hand, it had cash of CN¥565.1m and CN¥921.0m worth of receivables due within a year. So it can boast CN¥103.4m more liquid assets than total liabilities.

This state of affairs indicates that Ningbo Fujia Industrial's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥7.63b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Ningbo Fujia Industrial has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Ningbo Fujia Industrial's EBIT dived 19%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Ningbo Fujia Industrial can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Ningbo Fujia Industrial 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, Ningbo Fujia Industrial generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Ningbo Fujia Industrial has CN¥310.1m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥123m, being 91% of its EBIT. So we don't have any problem with Ningbo Fujia Industrial's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Ningbo Fujia Industrial that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.