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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Hangcha Group Co., Ltd (SHSE:603298) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Hangcha Group's Debt?

As you can see below, Hangcha Group had CN¥279.0m of debt at September 2024, down from CN¥981.1m a year prior. But on the other hand it also has CN¥3.51b in cash, leading to a CN¥3.23b net cash position.

How Healthy Is Hangcha Group's Balance Sheet?

We can see from the most recent balance sheet that Hangcha Group had liabilities of CN¥4.71b falling due within a year, and liabilities of CN¥407.6m due beyond that. On the other hand, it had cash of CN¥3.51b and CN¥3.44b worth of receivables due within a year. So it can boast CN¥1.82b more liquid assets than total liabilities.

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

Also good is that Hangcha Group grew its EBIT at 16% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hangcha Group 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hangcha 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. In the last three years, Hangcha Group's free cash flow amounted to 37% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hangcha Group has CN¥3.23b in net cash and a decent-looking balance sheet. And we liked the look of last year's 16% year-on-year EBIT growth. So is Hangcha Group's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Hangcha Group's earnings per share history for free.

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.