Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that COFCO Capital Holdings Co., Ltd. (SZSE:002423) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is COFCO Capital Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that COFCO Capital Holdings had CN¥9.91b of debt in September 2024, down from CN¥11.0b, one year before. However, it does have CN¥36.3b in cash offsetting this, leading to net cash of CN¥26.4b.

How Healthy Is COFCO Capital Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that COFCO Capital Holdings had liabilities of CN¥45.8b due within 12 months and liabilities of CN¥75.7b due beyond that. Offsetting this, it had CN¥36.3b in cash and CN¥3.40b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥81.8b.

This deficit casts a shadow over the CN¥32.6b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, COFCO Capital Holdings would likely require a major re-capitalisation if it had to pay its creditors today. Given that COFCO Capital Holdings has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

And we also note warmly that COFCO Capital Holdings grew its EBIT by 13% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine COFCO Capital Holdings's ability to maintain a healthy balance sheet going forward. 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 COFCO Capital Holdings 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 last three years, COFCO Capital Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While COFCO Capital Holdings does have more liabilities than liquid assets, it also has net cash of CN¥26.4b. The cherry on top was that in converted 392% of that EBIT to free cash flow, bringing in CN¥15b. So we are not troubled with COFCO Capital Holdings's debt use. 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 2 warning signs for COFCO Capital Holdings that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.