Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Nanjing COSMOS Chemical Co., Ltd. (SZSE:300856) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Nanjing COSMOS Chemical's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Nanjing COSMOS Chemical had debt of CN¥649.1m, up from CN¥611.1m in one year. But on the other hand it also has CN¥1.17b in cash, leading to a CN¥521.2m net cash position.

A Look At Nanjing COSMOS Chemical's Liabilities

We can see from the most recent balance sheet that Nanjing COSMOS Chemical had liabilities of CN¥396.5m falling due within a year, and liabilities of CN¥795.0m due beyond that. Offsetting these obligations, it had cash of CN¥1.17b as well as receivables valued at CN¥317.9m due within 12 months. So it can boast CN¥296.7m more liquid assets than total liabilities.

This short term liquidity is a sign that Nanjing COSMOS Chemical could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Nanjing COSMOS Chemical boasts net cash, so it's fair to say it does not have a heavy debt load!

Nanjing COSMOS Chemical'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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Nanjing COSMOS Chemical 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. Nanjing COSMOS Chemical 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. In the last three years, Nanjing COSMOS Chemical's free cash flow amounted to 21% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Nanjing COSMOS Chemical has CN¥521.2m in net cash and a decent-looking balance sheet. So we are not troubled with Nanjing COSMOS Chemical's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Nanjing COSMOS Chemical (of which 1 is concerning!) you should know about.

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.