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 Yantai Zhenghai Magnetic Material Co., Ltd. (SZSE:300224) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Yantai Zhenghai Magnetic Material Carry?

As you can see below, at the end of September 2024, Yantai Zhenghai Magnetic Material had CN¥1.24b of debt, up from CN¥1.17b a year ago. Click the image for more detail. But it also has CN¥1.94b in cash to offset that, meaning it has CN¥697.7m net cash.

A Look At Yantai Zhenghai Magnetic Material's Liabilities

The latest balance sheet data shows that Yantai Zhenghai Magnetic Material had liabilities of CN¥2.76b due within a year, and liabilities of CN¥1.33b falling due after that. Offsetting this, it had CN¥1.94b in cash and CN¥1.93b in receivables that were due within 12 months. So its liabilities total CN¥226.1m more than the combination of its cash and short-term receivables.

Having regard to Yantai Zhenghai Magnetic Material's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥11.5b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Yantai Zhenghai Magnetic Material boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Yantai Zhenghai Magnetic Material if management cannot prevent a repeat of the 38% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Yantai Zhenghai Magnetic Material 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. Yantai Zhenghai Magnetic Material 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. Over the last three years, Yantai Zhenghai Magnetic Material recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Yantai Zhenghai Magnetic Material has CN¥697.7m in net cash. So although we see some areas for improvement, we're not too worried about Yantai Zhenghai Magnetic Material's balance sheet. 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. We've identified 2 warning signs with Yantai Zhenghai Magnetic Material , and understanding them should be part of your investment process.

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.